2nd Quarter Client Note

The US stock market just had its best quarter in more than 20 years. (Yes, you heard that right.) Of course, that was on the heels of one of the scariest quarters in history, fueled by the Coronavirus pandemic reaching US shores in February. At its worst, on March 23, the S&P 500 was down 34% from its February 19 high, and lost a total of 20% in the first quarter.

In the second quarter, the S&P 500 (Total Return) Index gained 20.54%. All equity indexes made significant gains as well.

In the bond market, the Bloomberg Barclays Aggregate Bond Index gained 2.9%; spurred on by the unprecedented move by the Fed purchasing bond ETF’s.

As usual, a complete rundown can be found in the Quarterly Market Review from our friends at Dimensional Funds.

The Shape of Things to Come

We are experiencing a recession with the worst economic impact since the Great Depression. There have been multiple large businesses filing for bankruptcy reorganization. Thousands of small businesses have failed. Unemployment is at over 10 %. GDP is forecast to fall by 5% or more.

The course of the virus is going to control the course of the economy for at least the next 6 -12 months and is going to vary greatly by state. State officials, with reasonable minds – acting in good faith – can balance the trade-offs between the health damage and economic damage in different ways. Some states lean more libertarian and elevate individual liberty over the collective good. Others are more communitarian and emphasize working together to defeat the virus. Especially when it comes to wearing masks.

States that reopened prematurely are now slowing down and perhaps even reversing course. There’s going to be a lot of trial and error and states will have to be nimble. One commentator called what we are facing a three-way tug-of-war between managing the illness, the economy and our emotional well-being.

The race is on to produce a vaccine and the prognosis is reasonably good. But at this juncture it is impossible to know just how safe and effective it will be or when one or more will be widely available.

It’s tough to make predictions, especially about the future.

Yogi Berra

Epidemiologists are all over the map in predicting the future course of the virus. Will we see a series of small waves? A second surge like in 1918, with the onset of fall and colder weather? A lot will depend on our behavior as a society and the results of vaccine clinical trials.

Similarly, economists are all over the map forecasting what the shape of the recovery will look like. Will it be a V-shape – a rapid fall followed by a quick rebound? U-shaped – an extended recession of 18 or more months? W-shaped – a “double-dip?” L-shaped – a steep drop, followed by a long period of high unemployment and low or no growth? Or a Nike Swoosh – a long slow recovery?

I’m with Yogi on this one. It’s almost irresistible – especially with so much time on our hands – to make forecasts about what the future may hold; to apply to our portfolios and to the rest of our lives. What will happen in the next six months? Two years? In the decade ahead. I would prescribe a dose of humility, patience and whatever personal tools you have to cope with radical uncertainty. Plus, we have been handed a great opportunity to shape for ourselves what the “new normal” -whenever it arrives – may personally look like. Will the world look vastly different? Or pretty much the same?

Nobody knows. So, the best advice is to either live in a forecast free environment or to make small bets, none of which will cause you to go far off kilter if you are wrong.

Connecting the Disconnect

And yet…the stock market has seemed to mostly shrug it all off. Academics, professionals and pundits far and wide have been grappling for explanations.

For one thing, the stock market is not the economy. And the market has a psychology all its own. As famed behavioral economist, Robert Shiller, puts it: stock-market movements are driven largely by investors’ assessments of other investors’ evolving reaction to the news, rather than the news itself.

Most importantly, the stock market is also forward looking and discounts future earnings. But it’s impossible to know for how far into the future. And, in any event, the discount rate is near zero – and may be for an extended period.

Investors may simply believe that the worst-case scenario painted at the outset of the crisis, in neither the health effects (millions of deaths) nor the economy (a repeat of the Great depression) is likely to come to pass. Investors also generally believe that the federal government will continue to provide massive stimulus and liquidity to citizens, businesses and state and local governments to ameliorate the inevitable fits and starts that will be required to contain a massive spread of the virus. But that doesn’t mean we’re anywhere near out of the woods.

Such a phenomenon is not unprecedented. In 1982 the unemployment rate grew from 8.6% to 10.8%…and the S&P 500 gained 21.6%.

I trust the collective wisdom of millions of investors to “get it right” based on currently available information. That doesn’t mean things can’t change dramatically when there’s unexpected news. There’s no way of knowing whether we are in for more short-term volatility like we experienced in March. But you better be prepared for it.

Good Time for a Portfolio Checkup

The market’s second quarter recovery, which very well may not be permanent, provides a good opportunity for reassessment:

Matching risk with goals. As you get older, you naturally have fewer years of spending that your portfolio needs to support. (Of course, one can’t know exactly how many fewer years.) So it may be the case that your portfolio has a higher risk profile – in terms of allocation to equities – than you need to achieve your lifetime spending goals. But many investors have financial goals beyond simply supporting their life style; such as leaving behind an estate for heirs or charity. If you are taking on more risk than you need, that’s ok – just do it consciously after reviewing your overall plan.

Monitor Credit and Interest Rate Risk. If you’re going to maintain a portfolio with a considerable allocation to equities – say 50% or more – you would be well served to make sure the bond allocation of your portfolio is investment grade (with plenty of Treasuries) and isn’t stretching for too much extended maturity yield.

Build and Maintain a Cash Emergency Fund. While it may hold down your return in the long run, nothing beats having a sufficient cash reserve in the event matters get worse and stay there for a long time.

Tax Moves. Look for possible tax advantages such as tax loss harvesting, combined with portfolio rebalancing. Or Roth conversions.

Growth vs. Value. The stock market’s recent rise has been largely driven by high technology large cap growth stocks. Consequently, the valuation differential between growth stocks and value stocks is among the highest it’s ever been. So now may be a good time to rebalance your portfolio back toward value stocks. Broken asset classes tend not to stay broken forever.

Coping with Corona

By now almost everyone is only a degree or two of separation from someone who has died, become very ill or suffered financial distress on account of the virus. And it’s taking a psychological toll in the form of stress and anxiety and uncertainty. This makes it a real challenge to both live in the moment and not do anything rash to upset a good long-term plan.

There are lots of great methods for coping with the stress:

Eat well, get plenty of sleep and exercise. We are so fortunate in Summit County to have the beautiful mountains to play in right out the back door. Practice yoga or meditation. Stay connected. We’re all tired of Zoom; but it’s been a life saver.

One of the more interesting techniques is to make stress work for you.

And finally, Don’t lose hope.


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