Independent Thinking®
Weathering the Storm: Portfolio Investing in a Pandemic
March 28, 2020
As the United States shuts down in an unprecedented fight against a pandemic and more than three million people file for unemployment in a single week, Wall Street is making its bets on the economic outcome. The initial response was a 34% sell-off in the S&P 500 over a one-month period, and then a sharp rally on news of government rescue. But investors also need to see how quickly the federal government will be able to act; it won’t be easy to spend more than $2 trillion. The actual course of the virus and how quickly we return to something approaching normal behavior will be the most important factors impacting the markets.
No one really knows, of course. All we have to go on are examples in Asia, where the virus hit first and where economies are now beginning to reopen, and various epidemiological models. But the consensus of economists seems to be a plunge in second quarter GDP of between 10% and 25%, further but more modest declines of about 5% in the third quarter, and the beginning of a recovery in the fourth quarter. For 2020 as a whole, that’s a drop of between 5% and 10% in U.S. GDP, with a loss of upward of 10 million or more jobs. Earnings estimates are notoriously slow to adjust to such a sudden change in circumstances, but we have to assume earnings for the S&P 500 will be down by at least 20% or more.
The Federal Reserve is applying lessons learned from the financial crisis of 2008-2009 in acting as the lender of last resort to support the financial markets. In fact, the Fed is now going far beyond the actions it took during the last crisis in supporting a much broader list of securities, including corporate and municipal bonds. In addition, U.S. banks are in far better shape than they were going into that crisis. They have passed stress tests on their balance sheet that were comparable to the currently anticipated scope of this experience.
Additionally, Congress is attempting to inject $2 trillion into the economy. That represents about 10% of the country’s GDP. Just how quickly and effectively government can get these funds to households and businesses small and large remains to be seen. The timing is truly critical, as it will determine the number of jobs that could be saved and how many households should be able to bridge the gap to recovery.
In the interim, we as a society confront a terrible paradox. The more we shut down to flatten the curve, the more harm we inflict on our economy. The United States, like most of Europe and other developed economies, will be at near maximum shutdown to prevent an exponential spread of the COVID-19 virus while absorbing these expected hits to our GDP. We believe these current extreme measures aren’t economically sustainable. Difficult decisions will likely have to be made that balance health risks against permanent economic damage.
Most long-term investors are by nature optimists – and we count ourselves among them. Our democracy remains well balanced across the three branches of federal government, and the state and local governments. Information is rapidly disseminated and the potential for innovation almost certainly remains unlimited in our free market system. The entire world is now focused on the problem, which leads us to believe the outcome will be better than current consensus, developed under extreme uncertainty.
While it is not possible to predict the bottom of the market, it seems likely that this period will take the shape of a V; a rapid fall followed by a rapid recovery. So trying to time the exact bottom is not that relevant, as we likely won’t be there for long and will not be forced to sell.
The next few weeks will probably be extremely difficult for many people on many levels. We will all be concerned about our personal safety, the effects of unnatural isolation, and the fear of the unknown and the risks to the economy.
As the custodians of family and institutional wealth, our aim is to adjust client portfolios to ensure that they are sustainable through this downturn, with ample cash reserves, and are positioned to take advantage of opportunities as we start to see light at the end of the tunnel.
John Apruzzese is the Chief Investment Officer of Evercore Wealth Management. He can be contacted at [email protected].
Allocating Capital: Four Essential Guidelines
By Martha Pomerantz
A market timer and his money are often soon parted, especially in the face of recession and a bear market. Here are some of the capital allocation guidelines that we practice in all market environments:
- Stay focused on long-term client goals. Our asset allocation for each portfolio is aligned with client goals, spending habits, and attitudes to risk. It is essential to never lose sight of these considerations, however dramatic events in the markets might be.
- Practice disciplined rebalancing. Rebalancing portfolios to maintain individual target asset allocations makes sense in all market conditions. As equity values fall below the target in declining markets, rebalance. As they recover, make sure that the allocation to defensive assets remains on track.
- Utilize incremental purchasing. Buying at the very bottom, when the outlook is bleakest, is nearly impossible. Instead, we stage investments in a disciplined way. For example, if a 55% allocation to stocks declines to only 45% of the total portfolio allocation after a 30%-plus equity market drawdown, we’ll bring it back to 55% but rarely all at once. Adding exposure in smaller increments as the market declines and as it begins to recover provides investors with multiple good entry points.
- Value is relative. Market drawdowns are largely indiscriminate, taking down high-quality investments along with the rest. Good investors will always discriminate, looking for the best opportunities in existing and new markets.
We view this current sell-off as an opportunity to further enhance client portfolios, positioning them for strong, long-term expected returns. Investing in bear markets is challenging, both tactically and psychologically. But maintaining investment discipline goes a long way in protecting portfolios in tough times and preparing for better days.