Written by Tyler Simms, CFA, and Jason Maniotakis, CFA, on behalf of Private Investment Counsel, who believe in a holistic investment counselling approach to helping high net worth clients with complex needs.
"History doesn’t crawl; it leaps."
Nassim Nicolas Taleb
Six months since the World Health Organization (WHO) declared COVID-19 a global pandemic, we have witnessed the worst global public health crisis in over a century. The effects of the lockdown need little reminder—a nearly instantaneous economic recession, accompanied by record unemployment and the fastest collapse in stock prices in our lifetime. Alberta was also saddled with collapsing oil prices, further hampering the economy.
The many market environments of 2020
Although we are only eight full months into 2020, investors have experienced three distinct market environments.
First, we began the year with a tailwind from a strong 2019, pushing several stock markets to all-time highs by February 19th. Enthusiasm dissipated shortly thereafter and a record market decline ensued in late February. Beginning on March 24th, investment markets rebounded at a record pace.
These three distinct periods can be seen in the chart below.
Year-to-date returns of the Compass Portfolios as of August 31, 2020
Year-to-date returns of major market indices as of August 31, 2020
Both the Canadian (S&P/TSX Composite - “TSX”) and American (S&P 500) stock markets fell from their all-time highs on February 19th, to a bear market low on March 23rd. For the TSX, the peak-to-trough decline was about 38%, while the S&P 500 was about 35%. In each case, no historical precedent can match this steep decline in so little time. No reprieve was given, even for bonds, known for their defensive characteristics, which experienced their own troubles as corporate bonds fell 15% from their peaks during March.
Beginning March 24th, the S&P 500 posted its best 50 days ever and closed out the first half of 2020 over 41% higher than it’s March 23rd low. The TSX also recovered significantly, just under 39% higher than it’s March low. On March 24th, 2020 alone, the TSX surged nearly 12%—its largest single day percentage gain since July 1979. That same day, the Dow Jones Industrial Average Index gained 11%—its best day since the Great Depression.
When markets are volatile, how do we weather the storm?
Successful investing is driven by proactive planning practices, discipline and patience. This year has presented the ultimate test for investors on all of these fronts. Here are the principles this period has reinforced:
- Markets are really (really) unpredictable in the short term. Both the COVID-19 pandemic and subsequent stunning recovery were unexpected. Staying disciplined to your investment process proved critical to the long term health of investors’ financial plans.
- “Don’t fix your ship in a hurricane”. This is a favourite adage of Mawer Investment Management, one of the largest equity sub-advisors in the Compass Portfolios. The time to build a strong portfolio is well before a crisis hits, not in the wake of one. Given that market corrections are impossible to predict, the key is to structure a portfolio that will be resilient through a range of potential conditions.
- Diversify, it is critical for risk management. Diversification helped to avoid large losses in more challenged sectors like Financials, Energy and Real Estate. It also allowed the portfolios to participate in the gains of thriving sectors like Technology, Telecommunications and Consumer Discretionary. Corporate bonds have provided excellent returns so far this year and provide a much needed ballast to falling equity markets.
- Be bold when others are fearful. Cullen Roche, a professional investor, once quipped, “The stock market is the only market in the world where people run out of the store when prices go down.” Short-term market fluctuations are a function of human behavior, and people tend to panic when markets decline. Investors can take advantage of declining markets by actively rebalancing their portfolio from outperforming holdings to lagging ones. Rebalancing during periods of heightened volatility can help portfolios recover faster and boost the long term prospects of your financial plan.
What is the difference between the stock market and the economy?
Many investors are asking why the stock market and the economy seem to have decoupled throughout the pandemic and are curious what this means for the long term. As with all short-term market movements, there is no definitive answer as to why the stock market has done so well since March. However, there are three concepts that can help explain the sharp contrast between the economy and the market.
First, the stock market is not the economy, and the economy is not the stock market—however, they are related. There is a lot of nuance around the relationship between the two, but markets tend to be forward-looking and try to anticipate where the economy (and the companies within it) is going to be, not where it is today. We saw this when the markets fell sharply at the onset of the pandemic, when the economic impact of a global shut down was relatively unknown at that point. We are now seeing it again as markets have rebounded, while the economy is still finding its way.
Secondly, Barry Ritholtz—a frequent contributor to Bloomberg Business News— explains that the most visible market sectors can often be the smallest by market capitalization in the overall market. What this means is that our own corner of the country or province is not always representative of global markets on a larger scale.
“The economy we each experience – local, personal and (for the most part) not publicly traded – has been awful….. . These are highly visible industries, with companies that are well-covered by the news media with household names known to many consumers. Retailers are everywhere we go. Gas stations, chain restaurants and hotels are ubiquitous in cities and suburbs across the country. Markets are not especially affected by highly visible but relatively tiny sectors. So although high visibility industries may be of considerable significance to the economy, they are not very significant to the capitalization-weighted stock market indexes.”
Thirdly, interest rates have fallen further in the wake of a weakened economy. Lower rates impact stocks in two ways; first, they lower the appeal of bonds whose yields track market interest rates. In turn, investors find the relative prospects for stocks more attractive. Secondly, lower rates have a positive effect on how stocks are valued. Based on these methods of valuation, lower interest rates increase the value of stocks.
The dust never settles in investing
As we stand today, we appear to be beyond the initial shock of the pandemic and the global economy is slowly reopening with employment, company profits and investment markets recovering along with it. However, the dust never settles in investing, and uncertainty is a constant. This is the price we pay for the long-term benefit of market growth. Embracing uncertainty is what we are compensated for as investors. Stock and bond markets have, over the long term, produced returns well above more ‘certain’ alternatives, such as guaranteed investment certificates and savings accounts.
We have no doubt there will be speed bumps along the path to recovery from COVID-19. But when the pandemic subsides and the global economy recovers, investors will still have to deal with other risks such as geopolitical factors that add to short-term bumpiness in the markets, but largely become irrelevant over the long-term.
As investors, it is important to accept uncertainty, if not embrace it. After all, there is never a time when we can see clearly ahead, it’s only behind us that we can see 20/20.
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