Reopening, Social Change & the Markets

I can't remember a time when so many extraordinary events were unfolding simultaneously. Not surprisingly, people have been asking a lot of questions about why the markets have done what they've done over the last few months. Here are my responses to three of the questions I've heard most frequently since the recovery began.

When the Coronavirus crash happened, I thought the markets would have fallen farther and/or remained at their lows for longer. How did they recover so quickly in April and May when the news about Covid was still so bad? A market crash usually happens because investors don't think companies will be able to earn profits. The crash in March hit as uncertainty about the virus was peaking. Of all the uncertainties, the biggest unanswerable question was, "How bad is it going to be?" How many Americans would die? How many would lose their jobs? What would life be like under quarantine? No one knew the answers. Everyone was just making wild guesses. During this period of crisis, the Federal Reserve moved quickly. Between March 3 and April 9, the Fed made a series of moves with the potential to provide up to $6 trillion of liquidity to the U.S. financial and business system. This signaled to investors that the Fed would do everything within its power to minimize the damage from the crash. It also provided millions of individuals and businesses with the resources to continue spending. At the same time, the plan for flattening the curve become known to the public, and as people adopted social distancing measures, investors gained clarity on what the crisis might look like and how bad it would be. Covid-related deaths peaked in mid-April and then dropped steadily through early June. I think the market's rebound reflects investors' confidence that people would be able to get back to work and the economy could recover relatively quickly, and that the Fed would help out in the interim. 

When the protests erupted after the death of George Floyd, how could the markets continue to climb for another week? How could stock prices rise as footage of burning cities and police clashing with protesters dominated media coverage? Whenever I have to digest painful news stories and then try to focus on my job, I try to remind myself of this: The markets do not have a moral compass. They do not have a conscience. Stock prices reflect investors' confidence in companies' ability to earn profits. If I am saddened by news developments, I should not expect the markets to reflect my sadness. If I do, I will probably be disappointed. This does not mean that the investors who are participating in the market should not have a moral compass. Investors can vote with their dollars, choosing what businesses to buy from and which to invest in. I think the markets kept climbing based on continued confidence from the Covid crisis seeming to come under control in May. I don't think news of the protests affected investors' outlook on the economic recovery. 

Why did the markets fall last week after rising so steadily for so long? I think the dip last week was a reality check that the Covid crisis is not over. Last week we saw new cases and deaths rise again. With states reopening and many people losing their resolve to continue social distancing, investors feared the second wave was coming soon. Additionally, Fed chairman Jerome Powell made a statement last Wednesday that the economic recovery could take longer than some optimists were predicting. He said it could be "some years" before all of the 20 million Americans who lost their jobs were working again. This dampened investor enthusiasm and was probably part of the reason many of the major stock indices fell between 4-6% last Thursday.

Reinvesting: How to Get Back In

Last month I recommended that folks with investing timelines beyond five years should hang in there and hold on to their equity investments, if possible. Today I'm sharing thoughts for anyone who moved to cash and is trying to figure out how and when to get back in.

When the markets are in free-fall, many investors sell stocks because they can't stand seeing the value of their portfolios drop further. I completely understand the feeling. Many folks sell on the dip and plan to buy again after the worst has passed. It's an idea similar to the "Buy low, sell high" philosophy, except that unfortunately it reverses the order of those two actions. The problems become apparent when you realize that no one can tell you the perfect moment to sell or when to buy back again. There is no announcement at the exact moment when the markets start to descend into a crash or when they bottom out before the rebound.

No one can tell you when the worst is over, or guarantee that, from this day forward, the markets will only go up. It may be comforting to know that some of the greatest minds in investing are revered because of their ability to admit that they don't know exactly what will happen next. Accepting that fact allows them to develop strategies to move forward that mitigate risk while maximizing the likelihood of achieving long-term goals. If you sold equities in the last two months and want to develop a plan for reinvesting but you don't know how, please do yourself a huge favor and read this one-page paper by investing legend Jeremy Grantham called Reinvesting When Terrified. It will only take you five minutes to read, but it could change your investing outlook forever. He wrote it in March 2009 and it outlined his strategy for buying stocks at a time when it seemed like the markets might never go up again. And it's actually a pretty entertaining read. He recommends a phased approach for reinvestment. Making a small number of moderate-sized purchases -- spread out over a period of time -- diversifies your buying prices while ensuring that you are fully reinvested before too much time goes by. This will prevent you from missing the rally entirely and waiting on the sidelines forever, which is the greatest risk of selling during a crash.

I'll leave you with this brilliant line from the paper:

"Remember that you will never catch the low. Sensible value-based investors will always sell too early in bubbles and buy too early in busts. But in return, you may make some important extra money on the roundtrip as well as lowering the average risk exposure."

Accepting the reality that there is no way to be 100% sure what will happen tomorrow is the first step towards developing a plan for today.

How to Weather a Market Crash

Many people have an idea of investing in stocks that sounds like this:

1. Buy stocks, preferably at a low price.

2. Sell if you think prices are going to drop.

3. Buy everything back after prices have fallen, but before they start rising again.

4. Repeat steps 2 and 3 until you retire.

The problem with this strategy is that you'd need to be able to consistently predict the future in order to pull it off. A lot can change in six weeks. We're suddenly experiencing one of the worst financial crises in modern history. To make matters worse, our daily routines have been upended and it seems like our very way of life has changed overnight. It's a scary time for everyone. After one of the longest bull markets in history, it was a lightning-fast turnaround to bear market territory. The markets seemed to be in free-fall at times. Whenever stocks fall so far and so fast that the New York Stock Exchange hits its circuit breaker and shuts down during trading hours, you know it's bad. When it happens four times in 10 days, that's not just bad -- it's unprecedented. Long-time investors are reliving painful memories of the market crashes of 2008, 2001, and 1987. Anyone who started investing in the last 10 years is experiencing their first crash, and it's a big one. The message I have for DIY investors is the same one I have been giving my clients.

Hang in there. If you are still employed or if you have enough cash on hand to pay your bills for the next few months, stick with your plan. If your circumstances are different today than they were two months ago and you need money, that's a different story. If you've lost your job, you'll need to re-evaluate. If you don't have enough cash in your emergency fund, then pick the investments in your portfolio that you think are the most troubled and move them to cash.

But don't sell just to stop the anxiety that comes from watching prices fall. I've heard many horror stories from investors who sold during the Great Recession. They couldn't take it, and they got out. They planned on buying again after prices had bottomed out, when things were safe again. I completely understand the rationale and emotion behind this. But the vast majority of the times those folks sold at the bottom, they never got back in. That's how people lose half their portfolio - by not ever giving themselves the chance to gain it back. But I don't want to only tell you what not to do. I also want to give you some ideas about what you can do.

Below you will find my list of "15 Things to Do Before You Abandon the Stock Market." I hope it helps.

How to Weather a Market Crash

There is very little in investing that’s harder than watching prices collapse. Believe me, I see the same numbers you do. Last month I was on the phone nearly all day, every day, giving people my thoughts on why we should stick with one fundamental investing plan instead of cutting bait and moving everything to cash. I firmly believe that if you have a portfolio of high quality assets, doing nothing is often the best response to market volatility, even during the most extreme downturns. But when it comes down to it, every investor needs to make this decision for themselves, after looking at all the options. Stocks are for long-term money. Instead of going to cash, these are tasks you can accomplish in the short-term to improve your overall financial position without sacrificing long-term growth.

15 Things to Do Before You Abandon the Stock Market

1. Commit your budget to writing.

2. Figure out how many months' worth of expenses you have on hand in cash.

3. Figure out how many months' worth of expenses you have in bonds, for when your cash runs out.

4. Renegotiate your credit card debt.

5. Refinance your student loans.

6. Refinance your mortgage.

7. Get a HELOC.

8. Look at the top 10 holdings for all of your mutual funds.

9. Calculate the dividends and interest currently produced by your portfolio.

10. Read Warren Buffett's most recent letter to shareholders.

11. Read Jeremy Grantham's Reinvesting When Terrified.

12. Ask five people you trust what they did in 2008-09 and how it worked out for them.

13. Figure out the rate of return you want to have for a comfortable retirement.

14. Write down five companies you think will be wildly successful five years from now.

15. Write down a plan for how and when you'll get back into stocks.

After you do this simple homework, you'll have more clarity on what to do next, and you'll be certain that you made the decision with your brain and not with your gut.

Know Your Investing Timeline

At the end of January, coronavirus news sent the markets into a tumble. But last week's collapse made the January slump look like small potatoes. Historic market drops remind us that markets are volatile and unpredictable. Bear markets and recessions happen. And unfortunately, there's no way to predict exactly when they will happen, how bad they'll be, or how long they'll last. That's why you should protect any funds that you expect to use in the next 5 years from risk.

You'll want to avoid investing that amount in stocks or anything else that could tank in the next recession, market crash, etc. So this month I'm writing about the importance of knowing your own investing timeline. It's a helpful defense against that sinking feeling you might have in your stomach during times like this. I love my house, but we don't have enough closet space. Most of our closets are filled with giant tubs of things we're not currently using. Holiday decorations, hand-me-downs that the girls haven't grown into yet, mementos, you name it. Our bedroom closets are small. When we remodeled our house, we opted for more room in the common areas and less room everywhere else. I make it work by keeping my closet seasonal. When I open the doors, I only see items that I'm going to wear that season. If I'm not going to wear it soon, it goes in a tub, up on a shelf, out of the way. If there's a chance that I am going to need a certain item, I keep it where I can easily get it.

Your portfolio needs to work the same way. The end goal for most investors is retirement. As I've often written, most investors need to target a higher rate-of-return in order retire comfortably. This means embracing risk in long term investments. I'm a big believer in stocks, while some prefer real estate or other investments. It all depends on what you're comfortable with. You'll rely on these long term investments to create the wealth you need to retire. But their value will probably rise and fall a lot between now and then. For these long term, high growth investments, you should only invest in funds you will not need anytime soon. You don't want to be forced to pull money out at the wrong time, when prices are falling.

This is why you need to create an investing timeline and allocate your portfolio accordingly. Here's what I tell my clients:

• Identify the major expenditures you know or strongly suspect you'll be making in the next 5 years.

• Put the money for those expenditures where it will be accessible when you need it. Your options are cash, bonds or CDs that mature on a coordinated schedule so you avoid paying early withdrawal penalties.

The reason for the 5-year time frame is simple. No one knows when the next bear market, recession or market collapse will happen. And when those events do happen, no one knows how long the markets will take to recover. But history suggests that 5 years is probably enough time for markets to recover from even the worst crashes. These funds won't grow when the bulls are running but they won't evaporate when the markets fall, either. Your money will be there, predictably, when you need it. There is no consensus on how bad the human toll or financial cost of the coronavirus will ultimately be. There is no consensus on when the markets will return to their historic peaks of just a few weeks ago. So know your timeline, stay diversified, and keep riding it out.

The Coronavirus, Uncertainty and Dow 30,000

The coronavirus has become one of the top news stories in the world. It sent markets tumbling last week just as the Dow Jones seemed on its way to hitting 30,000 for the first time. In the media industry, the phrase "above the fold" refers to the front page newspaper headlines that appear above the crease where the newspaper folds in half.

The editors place the day's most important news above the fold so that when you walk out to the end of your driveway and take the newspaper out of its sleeve, these are the first stories you'll see as you walk back into the house. I still get print delivery of the Wall Street Journal each day, so I've watched the coronavirus news creep up from below the fold (last week) to above the fold over the last several days. There's no question that investors are assigning great importance to the news out of China. Just two short weeks ago, much of the investing news focused on the approach of Dow 30,000.

But as the coronavirus spreads, the talk in investing circles has changed to how the quarantines, travel bans and business closures will affect the global economy as China's officials try to get a handle on the situation. After hitting an all-time high of 29,348 on January 17th, the Dow Jones Industrial Average fell over 1,000 points to close at 28,256 by January 31st.We know that the coronavirus is disrupting international trade and supply chains, and that corporations are making difficult decisions in real time with incomplete information. But the long-term impact of such moves is unclear. One could point to the relatively minor market slumps after the SARS outbreak in 2003 as cause for optimism. One could also point out that coronavirus could have a bigger economic impact than SARS did because China's importance to the global economy is greater now than it was in 2003.Investors don't like uncertainty, and the outbreak is adding even more uncertainty to an already unpredictable election year. So what's an investor to do? If you've been reading this blog for any length of time, you know I'm adamant about investing for the long-term, particularly when it comes to stocks.

Regardless of whether we're talking about coronavirus, elections, yield curves or recessions, it is much easier to make a long term plan and implement it than try to guess which way short-term stories are going to play out. It comes down to this: When you invest in stocks, you're buying a company. The company is not just the goods or services they produce right now, but also the new ideas that company will come up with in the future. You're investing in the company's leadership and its ability to navigate periods of uncertainty and adversity. You're investing in the company's ability to adapt. If I think a company can only succeed when the economy is roaring and market conditions are agreeable, I don't invest in that company. I invest in companies that I believe can weather storms and continue to create value for their investors, even when challenging circumstances arise. We will be inundated with bad news for our entire investing life. There is no "All Clear" signal when it's safe to come out of your bunker. If you're always tangled up in the headlines, you'll miss the opportunities that are constantly being created as the world changes. Hang in there, work your plan, and keep a long term perspective.

Decades: Investing for the Long Term

With a new decade on our hands, it's time to zoom out and take a look at the big picture. I was so busy last month, it didn't even occur to me that we were on the verge of a new decade until I saw people posting about it on Facebook. Now that I'm in reflection mode, I'm wondering about the significance in the ending of one decade and the start of another. In the 1980's I was a little kid, and in the 1990's I was a teenager. I graduated college and moved to Austin just after the millennium, thus beginning my adult life.

I became a parent and business owner in the early 2010's, and that gets us up to the present. Looking at my life this way, it seemed funny to think about how big the differences were between those life chapters. In between, there were a lot of noisy moments and decisions that seemed big at the time. What classes to take in college? Which car to buy? What school to enroll my kids in? But compared to the difference between being a teenager and being a mom, the differences between the options I had for those smaller decisions don't seem quite so dramatic.

Sometimes it's good to zoom way out to get a different view from how things look day-to-day. Which leads me to my favorite kinds of charts -- the long term ones.

The S&P 500 by decade

https://www.macrotrends.net/2324/sp-500-historical-chart-data

The chart above shows almost a century of the S&P 500. We see lots of zig-zags and some extended slumps, but overall, a general upward trend. Now let's take a closer look at the last 30 years for a more recent big-picture view:

https://www.macrotrends.net/2324/sp-500-historical-chart-data

The vertical gray stripes indicate periods of recession. The first one is around 1990-91 and it led to George HW Bush being voted out of office. The second is basically the dot-com bubble bursting, compounded by 9/11. The third one is the Great Recession. Let's find the value of the index at the start of each decade. The S&P took a dip at the beginning of the 1990's but then rocketed up more than 200% by the end of the decade. The 2000's saw the index take two major hits, cutting its value in half at the low-point of the Great Recession. By the beginning of the 2010's the recovery had begun, and it's been chugging up ever since.

So the big picture is... over the last 30 years the S&P increased in value by 389%.There were some massive swings within each decade, but the overall takeaway is that long-term investing in the S&P paid off.

Deciding which investments to make and when to make changes are tough decisions. But they're not nearly as important as whether you are saving and investing and whether you stay invested for the long term. It's not easy when the markets take a dive, but sticking with your investing plan through thick and thin - while making the necessary adjustments - is the only way to gain the benefits of compounding. And that's how you see real growth in your portfolio over the long term.