Q2 2020: Intermission for the Protagonists
Intermission for the Protagonists
The first half of 2020 has felt less like reality and more like a Hollywood summer blockbuster complete with drama, action and intrigue. Only no one told us we were cast as the main characters in this drama! We are careening from one scene to the next, following the storyline toward an, as-of-yet, unknown ending. Impeachment. Pandemic. A market crash. Public killings. Protests. Mass layoffs. Recession. Lockdowns. Social distancing. No sports. No theatres. Nothing whatsoever to distract us from the unfolding real time spectacle.
We find ourselves midway through this drama, hoping for Vonnegut’s Cinderella (rise-fall-rise) story plot, and dreading Oedipus (fall-rise-fall). The first half of this year has been exhausting. The protagonists are fatigued. Vigilance, after all, can only be maintained for so long. We can certainly identify with a main character in a tragic story. Tough times can be hard to endure. It is human nature to want to move from that low feeling back toward a high feeling, or at minimum, a reasonable resolution. As we head into the second half, much remains unclear and unknowable. When will we have a vaccine? How long until millions regain their jobs? How contentious will the election become? When will life feel normal again?
The ultimate outcomes to many of the current issues are unknowable right now. And that is OK.
Market Review
If you add up the daily price change of each trading sessions of 2020, the S&P 500 index (an index of the best companies in the largest and most liquid market in the world) has traveled an extraordinary total of 237.6%. First, markets rose for 6 weeks, then plunged during a 5 week drop of -33% between Feb 19 and March 23 and then a government engineered asset price “recovery” ran higher through most of the 2nd quarter. As the first half of the year ended, the older and somewhat “stodgier” Dow Industrials were down 9% . Growth stocks again outperformed. Large tech companies were able to remain open and benefitted from changes in consumption and daily routines.
If a person were fortunate enough to have avoided all news and events from the past five months, and only looked at their portfolio balance as of June 30, that person might believe very little actually happened. They might be astounded to learn that a worldwide pandemic caused the US government to shut down a large portion of the economy. Or that 21% of the working population had lost their jobs (most since the Great Depression). Or that 12 million people around the world had been confirmed with Covid-19 and more than 550,000 people had died.
For most investors, the 2nd quarter asset price recovery has been a welcome respite during an otherwise tough year. For some though, the rally feels false, with stock prices completely disconnected from everyday life on “Main Street.” This divorce between the everyday reality for millions of people and the asset price recovery in public markets is the result of two enormous government actions. First, the government response (lockdown) to the virus, and second the government response (stimulus) to the first government action. Like the 1962 thriller King Kong vs. Godzilla, this year’s drama pits two huge forces against each other. It might be titled “The Fed vs. The Lockdown.” With trillions of dollars and potentially millions of lives at stake, this real-life drama has considerable implications.
A recovery rally can often leave investors feeling like the worst is over. After all, every major market decline in history has followed with a recovery rally. Some rallies are sharp and some take years, but the markets have always recovered from major declines and gone on to new all-time highs in later years. Anything is possible this time. So much is unknowable, and the amount of money being used to restart the economy is unprecedented. We are fortunate that the Fed, our central bank, has such enormous clout. Without the backing of the central bank, many more poorly funded and badly leveraged businesses would fail and the US economy would endure a deep reset.
Covid-19 cases are still rising. The US seems to be moving toward an unspoken herd immunity solution. Based on news reports, we are likely to have a vaccine by mid-2021. Either of these outcomes are likely to take another 9-12 months. This movie is not yet over. We all want to believe the worst is past, but we should act in prudence, maintaining proper investment allocations and exercising patience. If another wave comes later this year, we want to be survivors of that event and buyers of that opportunity.
The “X” factor
Long time readers of this commentary know that I often address the “x-factor” of humanness and the impacts on investment decisions. Asset allocation and security selection are important determinants of investment outcomes, but behavioral finance also recognizes that most investment portfolios do not exist in a vacuum devoid of human interaction and are therefore influenced by the human element.
Surveys show that individual investors who make their own timing decisions underperform markets by a large margin. This is the human “cost” to investment performance, and it is often the most significant factor in successful investing or failure.
When short term outcomes are wildly diverse and the most foundational aspects of life are in flux (health and finances), it is a mindset that can make all the difference. When the Apollo 13 mission suddenly went sideways and running out of oxygen became a very real and possible outcome for Jim Lovell and the crew, their training kicked in. Their mindset guided the astronauts and the ground personnel in Houston to essentially stop and take stock of the situation. They did not panic or spend time on what went wrong, they looked at the facts, assessed what resources they had available, asked a series of questions and then proceeded to fit a square (command module filter) peg into a round (lunar module filter) hole. If they had stopped even for a few minutes to worry about carbon dioxide or to mourn losing the chance to land on the moon, they may not have made it home alive. Their response to that crisis is also the best response for investors in uncertain times. Accept the past. Recognize the facts. Review the plan. Commit. Once these steps are complete, then move into what I would call a state of “active patience.” The impacts of the lockdown and the ongoing fight against Covid-19 will continue for a while. Perhaps into 2021, or beyond.
It will take patience and resolve to wait for opportunities. It’s been a long five months since the virus became center stage of a global drama. And while we may not go into lockdown again, a mass-produced vaccine or herd immunity will take a considerable period of time. And that is OK.
The current environment is largely unknowable. Even corporate executives managing public companies do not know. More than 40% of S&P 500 companies have withdrawn earnings guidance, effectively communicating the potential for abnormal profits or losses this year.
We do not need to try and guess market tops or bottoms. An asset allocation strategy built on a financial plan is powerful, and it works. It requires certain actions and it requires patience. Because the right actions over a long time horizon results in higher investment values. Sure, the short run can be volatile. But the long run is far more knowable.
Thou shalt] Know Thy Denominator (or be branded a speculator)
Investing is not easy, but there are some simple truths. One truth is that buying low and selling high are good practices. But buying low (when future return expectations are high) and selling high (when future returns are low) can only be done when the denominator is known or predictable. What price would you pay for a rental property? Only a speculator would offer a price without knowing what rent the property could generate. The rental income is the denominator that determines return. What price would you pay for a stock? Again, you would need to know about the company’s earnings and future growth. Assume I say that you made a 10% return. Would you be happy? You would want to know if that return took a month, 3 months, a year or 5 years. Time is the denominator that determines whether 10% is a fair return or a low return. When any denominator, whether earnings or time or people or any number of other things, is unknown, the return on that decision is also unknowable.
When there is both a known denominator and a fair open market price then true investing can occur and expected future returns can be calculated. For now, many denominators remain unknown and price discovery (fair open market prices) has been clouded by Fed interventions. Lately, it has become a speculators market. And that is ok. We can be patient. Just knowing that we don’t know is powerful.
TV gameshows have shown that offering a chance to win big piles of cash can cause human contestants to do just about anything to win. The Federal Reserve has offered the biggest pile of cash in history. And cut the cost to borrow to nearly zero. Is it surprising to see millions of new day trading accounts opened and margin and options being used to buy stocks?
We will continue to invest, not speculate, and commit to the financial plans and asset allocation strategies that guide our portfolios. As we enter the 3rd quarter, there are few “fat pitch” opportunities. And that is ok.
It is a time to be patient. It is a time to have some liquid and safe assets ready for future investing opportunities. When we have safe reserves and time is on our side, and we have a plan that we are committed to executing, we know from history that we will ultimately win the day. And achieve our investment goals. And that is better than ok. That is really good.
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