Q. How about that stock market rally on Friday? It has to mean Thursday was the bottom right and this was that quick turn you’ve talked about before?
A. Honestly, I doubt it. And I don’t mean that stocks are going to immediately just give that all back, though they certainly could. What I mean is that the stock market is constantly adjusting to price in all known current information and all opinions of those who are invested in it. If the average investor thinks that prices for a company, sector, asset class, country, index, or the market as a whole are too high, then that average investor will be buying less at the current price than selling. That makes prices fall, sometimes rapidly, to a lower point where equilibrium is established again. The reverse of course is true as well. If the average investor, known all they know, thinks prices are too low, then there will be more buying than selling at the current price, thereby pushing prices up. Right now, markets are getting lots of new information daily, sometimes minute-ly (don’t think that’s a word, but let’s go with it anyway). Opinions form, sometimes overreacting, sometimes underreacting, though we never know when that’s the case. Friday’s snap back from Thursday’s ~10% move down is more shifting opinions, more new information, and more projecting the future beyond covid-19 and an oil price war. The odds are good that the market is still fairly priced and if it’s not, we don’t know whether it’s overpriced (near term shock will be worse than expected, recovery longer, long-term impacts) or underpriced (near term shock will be better than expected, recovery shorter, few/no long-term impacts). The key part of that last sentence is “than expected”. We can’t simply read the news, say that covid-19 cases and deaths increased, and think that would cause stocks to lose value. What causes stocks to lose value is when things are worse “than expected”, in aggregate, and that worse than expected result is validly projected into the long-term future. No one can tell you when the stock market is going to bottom or has bottomed, just like they can’t tell you when it is going to top-out or has topped-out. It would be much wiser to say that the best guess is that the market is fairly priced, is most likely to produce average returns from here, but that the likelihood of a wild swing in one direction or the other remains.
Q. Well, that’s disappointing. Everything’s so depressing right now… can you give me a few positives as a result of what’s happening?
- Long-term interest rates are extremely low. That’s not just great for refinancing personal debt (e.g. mortgages), but it also means something important about asset prices. A company’s value today is determined by a projection of its future profits, but typically the short-term profits are weighted much higher than long-term profits because of the interest rate you can earn on those profits each year as they’re collected. If interest rates are high, say 10%, you’d rather have a dividend right now and reinvest it at 10% than get it five years from now. That makes the short-term much important relative to the long-term in determining current value. When interest rates are as low as they are now, the value of the next year’s profits is a much smaller portion of a company’s total value. This is extremely important in the sort of scenario we’re living in now where the disruption to profits seems temporary. Losing year one of profits with minimal/no impact on years 2 thru infinity should not change current value by that much, at least not in aggregate (individual company’s might have debt which forces them out of business if they can’t make payments, but then another company that survives takes their revenue going forward). Warren Buffett invested in an airline yesterday. I suspect, he’s using this kind logic in buying the worst possible investment for news flow (ex-cruise lines), at exactly the worst possible time looking at near term profits.
- Gas prices will likely be in the ~$1.50 range nationwide in the next couple of weeks. Most people aren’t doing a lot of commuting / traveling right now, but when they do, those cheaper prices at the pump add up to more money in consumer pockets.
- More on interest rates… I don’t know if we’ll do this, but the country has an opportunity to extend the maturity of short-term debt to the very long-term without paying much higher (and sometimes even lower) interest rates. Some countries have 50-year and 100-year bonds. For some reason, we don’t go beyond 30. If we could refinance our national debt at low, fixed, long-term rates, it will give some leeway to fixing our fiscal issues.
- We’re going to be able to refill the strategic petroleum reserve for the US at prices that seemed unimaginable 10 years ago. The next time there is an oil supply shock, we’ll be much better positioned as a result. (Aside: shouldn’t we also have a strategic medical supply reserve? *sigh*).
- For those who are still adding to their portfolios, which are generally the ones that will take the biggest hit from stocks falling in value since retirees don’t have all their money in stocks, the opportunity is substantial. I don’t mean that stocks are a fantastic opportunity now and they should pour money in at current prices. But, investing steadily through the rollercoaster will get you to a higher ending portfolio value than investing the same way in a market that just moves steadily upward. See https://blog.perpetualwealthadvisors.com/2013/06/20/the-value-of-volatility/ for examples.
- The worldwide fiscal and monetary response to our current challenges is going to be enormous. This has some long-long-term consequences, but for the medium term, it can’t be anything but a positive. The last decade has also made it much more commonplace and acceptable for the Federal Reserve to pump money into the economy to replace a lower velocity of money due to forced deleveraging. Quantitative Easing (QE) takes a lot of credit for keeping us out of Great Depression II following the financial crisis. There’s a fair chance an even stronger response could come this time if things get dire. Did you know that Japan’s equivalent of the Federal Reserve purchases equity ETFs (i.e. stocks)? Our Fed doesn’t have that mandate from Congress, but I wonder what happens when a national emergency is declared and the president has broader executive order powers? Hmmm…
Q. I feel a little better. Still though, from a financial standpoint, there are tons of people on CNBC and other stations saying they don’t want to be in stocks right now and haven’t been in stocks while this was happening. What do they know that we don’t know?
A. There are lot of doomsayers out in the press right now, taking victory laps because the market is down, even though many haven’t been bullish since before the great financial crisis. Maybe some of you reading this fall into that camp internally as well, feeling like you knew this was going to happen, but thinking back, you’ve felt that for so long that if you had acted at that point, you would have missed out on much more growth than you have lost in the last month. Still others may have nailed their “top” call at exactly the right moment. Surely you will be hearing from them at times like this. There are a lot of people in the world making predictions though and if you frequently make bold ones, you’re bound to be correct and may even find yourself on TV celebrating it. CNBC presents cheerleaders when markets are doing well, calling on people to buy hand-over-fist and perma-bears proclaiming the end of the financial world during a crisis. It’s what gets ratings. It’s also the people who are willing to come on their shows since they’ve been recently correct. It’s not hard to find people who are correct, even several times in a row… If you flip 10,000 coins 10 times, odds are that about 10 of them will come up heads every time. It doesn’t mean the coin has an advantage over the other coins. It means you’re not hearing from the other 9,990.
Q. How do you stay calm about all this? Aren’t you worried at all?
A. In all honesty I have my moments of personal freaking out at times like these, just like many of you that are reading this. Like the old Hair Club For Men commercials for those of you who remember them, I’m not only an advisor, I’m also a client. It’s ok to let yourself feel emotion. It’s just not ok to act on that emotion and do something that you planned specifically not to do exactly in a case like this. I know I signed up for riding a long, upward-sloping roller-coaster the first time I invested. I know with almost certainty that there will be dips of 50% on this ride, with the possibility of more from time to time. I know that it won’t look upward sloping during those dips. I also know that investing in aggregate in the ingenuity of humans and the ever-rising productivity and technological growth of our society is the best way to build long-term wealth. It is the reason why the roller-coaster slopes upward over the long-term. I also know that money I may need in the short-term isn’t invested all in stocks and in matching that return/risk profile with my family’s goals, there’s really nothing to worry about over the short-term. I still worry because I’m human, but my plan gives me comfort. I also sometimes feel like I know what the stock market is going to do (especially in hindsight!!!). During the financial crisis, I convinced myself I knew it was going to happen (in truth, I knew real estate couldn’t rise 15% forever, but I had no idea the depths that we’d be going to in early ’09). I knew after the sharp rise in stocks in spring of ’09, that we were going to revisit those lows again (we didn’t). I knew that the Fiscal Cliff disaster was going to crash the market (it didn’t). I knew that the financial system was going to crack when Europe ex-Germany was inching closer and closer to defaulting on their government debt (it didn’t, and not only didn’t it, but that government debt turned out to be one of the best investments ever for those who bought at the brink of disaster). Now, I’ve had good internal calls as well over the years, but I remind myself frequently about that coin flipping that I mentioned above. In short, I give myself time to freak out, I moan and groan, I remind myself of the futility of market-timing, I pull myself together, and I get back to regularly scheduled life. If any of you, my clients, find yourself stuck between freaking out and getting back to regularly scheduled life, please call me. I’m also a client and I know what it feels like. It’s the reason I write these posts when times are tough. I’m talking to me as much as I am to you. And, I’m listening.