Dear Clients,
To help understand our current situation, it is sometimes helpful to look to history as a guide. Each financial downturn is different, but they often share common elements.
1987
In 1987, stocks dropped -22.6% in one day, Black Monday. Stocks were trading at very high P/E ratios at the time. Once some selling began, computer trading took over and greatly accelerated the losses. The 1987 bear market was short-lived, needing only three months to move from peak to trough. Since then “circuit breakers” have been put in place to temporarily halt trading should the market drop by a certain percentage. This pause allows humans to reassert control over trading instead of computers simply placing sales because a certain price has been reached.
2000
In 2000, overinflated share prices, particularly in the technology sector, reached their limit. The ‘dot com bust’ decline in equities was the classic deflation of an asset bubble. All at once, investors realized that the fantastic price of technology shares was just not justified. This bubble deflation was a long, drawn-out affair, with markets generally declining for 30-months.
2008
The financial panic of 2008 was not the result of stocks being too expensive. Rather, it came courtesy of excesses in other parts of the financial universe. Mortgages and other financial instruments were being valued at prices much higher than they should have been. Once these excessive valuations were realized there began a spiraling collapse that shut down banks, brokerages and more. The recession spawned by this particular accounting reevaluation was long and severe, and the recovery was complicated by holes in the fabric of the global financial system. The Federal Reserve and other central banks used different tools to help the recovery along. Congress passed funding and bailout legislation (remember TARP?). They’re now using some of those same programs and strategies to address our current situation.
2020
What will the eventual 2020 market decline look like? No one knows just what trajectory this will take, as it will depend on how quickly we can control the virus and how rapidly the economy responds when we all get back to our normal routines. Markets will try to anticipate what will happen and – if history is any guide – they are likely to move higher once uncertainties begin to clear.
It may seem obvious, but it is worth noting that through the bear markets of the last four decades, periods of significant market decline were followed by a robust recovery. Each recovery was different, but all were significant in the year following the market bottom. This is so important to your financial health that we want to repeat that last observation. In the last three bear markets we’ve had the pleasure to live through, there were substantial returns once the selling stopped.
Sooner or later the curve of new cases will begin to flatten and the stay at home orders will be lifted. People will go back to work; businesses will open their doors and the economy will begin moving forward again. Sometime before then, investors will likely begin to see light at the end of this dark tunnel and start tiptoeing back into the markets. We’ll see asset prices begin to normalize and investments look attractive once more. Very likely, parts of the market recovery will be swift and substantial. We may see a rush back into equities, as investors hurriedly redeploy the kinds of investments they just should have kept in the first place.
Over this time of uncertainty, we’ve witnessed some extraordinary initiatives that have gone a long way toward stabilization. The three stimulus plans already passed by Congress and signed by the President are breathtaking in size and scope. Their aim is to help families and businesses stay afloat while waiting for the virus to abate and the economy to improve.
While we will be sending further communication regarding the recently passed legislation soon, we do want to take a moment to mention one provision in particular. The Required Minimum Distribution (RMD) for IRA’s has been suspended for 2020. For those of you who do not need/want the distribution, you will be able to skip taking it for 2020. More to come on that important change.
The Fed has also taken significant steps over the last month to stimulate on one hand and ensure a properly functioning financial system on the other. The lessons learned during the financial crisis were not wasted. Having built these initiatives before, neither the Fed nor Congress wasted any time in implementing similar programs. These will help over the next several months and there are already calls for additional stimulus going forward.
Many economists have made a distinction between the current situation and 2008. Banks are in good shape today with ample reserves. While the immediate future is quite uncertain, we could begin to see economic activity resumes in the 3rd and 4th quarters of this year. In 2008, the financial uncertainty continued for quite some time and required substantial remediation for years. While it is probable that we will encounter a recession this year, economists are predicting it will be a short-lived affair.
The recovery beginning in China is starting to provide a little more clarity on the possible trajectory of the economic slowdown. They are cautiously reopening travel and manufacturing facilities are resuming work. With many of their markets here and in other parts of the world at a standstill, they will likely be slow to resume growth, but it is encouraging to see a glimpse of a partial return to normalcy in this otherwise unusual situation.
Market declines like this create some opportunities, and we’ve taken advantage of those. Each of your accounts has an investment blueprint (we call it an Investment Policy Statement) that we mutually agreed was appropriate for you. When markets change as dramatically as they have, the balance of the portfolios becomes skewed toward the investment types that have been relatively strong. This provides the opportunity to rebalance the portfolio. In rebalancing, we have sold a small portion of the investments that have done well and purchased in asset classes that have borne the brunt of the selling. If a hypothetical account was designed to hold 50% each in stocks and bonds it likely looked like a 60/40 mix of bonds and stocks by early last week. In that case, we brought the portfolio back to balance by selling some of the bond holdings and purchasing discounted stock holdings. This can be helpful in enhancing returns over a market cycle like the one we are currently experiencing.
This pullback also made it easier to make changes in portfolios without the concern of taxable consequences. This market substantially reduced unrealized gains and made any anticipated changes easier to implement.
As such, we’ve made some changes in your portfolio holdings. Over the last several years we have witnessed the maturity and expansion of the Exchanged Traded Funds (ETF) market. With the ever-expanding list of available investment options and high level of liquidity, we feel comfortable incorporating the lower cost ETFs within your portfolios in asset classes where we think they make sense. We’ve been able to make those changes recently in many portfolios.
We encourage you to remain committed to the investment strategy and planning work we have done together. They accounted for years like these. For many reasons, we don’t think it is possible to time the market and we don’t try. Rather, diversification among asset classes has proven and continues to prove helpful as we work our way through this.
We will, as a global and local community, get through this difficult time. Until then, we have a lot of work to do, helping those less fortunate and supporting our health officials in putting an end to this pandemic.
We appreciate your continued trust and confidence.
