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Planning and Investing in a Panic (Lombardo Pearce Group)

Times such as these can be very emotionally disturbing, and raise the question of whether our assumptions about the future were correct in the first place. We would like to share with you how we think about investing and planning when the ground appears to have shifted under our collective feet. 

Since we rely on imperfect stock and bond markets to assist you in your long-range planning, we have to make some assumptions about their future performance, and in periods such as these, those assumptions appear more suspect.  Despite the wild and unpredictable nature of current market movements, we do have some observations about how they often behave in the long run which will guide us in thinking about your situation.

Most stock markets around the world have fallen between about 20% and 30% in the past month.  This is an abrupt way for an eleven-year (US) bull market, and economic expansion, to end, but abrupt ends to bull markets have many historical precedents.  The nature of each precipitating crisis is different.  In the past twenty years we have seen the dotcom bubble collapse in 2000, before the World Trade Center attack which closed markets for a week.  This was followed by the real estate bubble in 2008, and now the coronavirus pandemic.  In 1974 it was the oil embargo which caused massive adjustments, and again in the 1980s when the Federal Reserve’s tried to break an inflationary spiral. The 1987 crash caused a one-day decline of nearly 23% alone, but was not accompanied by a recession. 

Despite their uniqueness, most panics have similar patterns:

  • An optimistic complacency in a high-priced market is shattered by a catalyst, causing equity prices to decline, and reminding us that economic cycles still exist;
  • Policy makers and the general public take too much time to recognize the extent of the problem;
  • Policy makers struggle with political and ideological differences until corrective actions become imperative;
  • Supply and demand both fall as spending behaviors change; 
  • If the first phase of corrective policy actions fails to stabilize the situation, more actions follow;
  • Recession and bear markets play out until evidence of more enduring stabilization of aggregate demand begins to emerge.

In today’s case, the virulence of Covid-19, compounded by the slow diagnostic response from the central government, adds a significant element of both risk and uncertainty to the present situation, and until the nature and extent of the problem is more clear (which we presume will eventually occur), the markets may continue to assume the worst.  In addition, the closure of large segments of the economy as the best antidote to the expansion of Covid-19 implies that recession is actually part of the cure.  The question for investors is how long this situation will prevail, how can the government mitigate both a health crisis and lost income simultaneously, and when will a semblance of normalcy return.  Unfortunately, we cannot know until afterward, but we can try to apply some sensible judgments based on experience.

In the past several years we have asked our clients to consider their tolerance of investment risk, sometimes based on (often repeated) discussions, and many times using a standard questionnaire. How we have invested is then determined by what your tolerance seems to be, and what your financial plan seems to require of you to arrive at your long-term goals. Sometimes the capacity for risk is less than a plan requires, and sometimes it’s greater, depending on one’s financial situation.

The difficulty in attempting to assess risk tolerance, or risk of near-term loss, is that when done in good times, when profits seem easy, we feel more tolerant of risk than we actually are when markets reverse course.  We think of reality as what we most recently have experienced, and when that reality shifts, it may be hard to adjust emotionally to reversals of near-term fortune.  In fact, it may take several market cycles to truly “know thyself,” as an investor well enough to be able to “stick with the plan,” as we and others in our line of work so often exhort.

We don’t know how far down the current the crisis will take world stock markets, or how long a recession may last.  There are no easy answers to the question of “what is the right thing to do?”.  However, we assume, as we have in the past, that the lower asset prices fall, the better the long-term rates of return will be going forward, beyond the short-term pain.  Therefore, if you are still comfortable with the allocations we have established for you, our plan is to eventually to replenish fallen stock allocations with reinvestment from the bond side of portfolios.  This will allow us to shift from now very low yielding bonds to higher long-term equities.  The timing of such a move can seem random as we do not know how far markets can fall, so we will adopt an incremental approach rather than rebalancing all at once. This strategy is very difficult in adverse market environments, but is essential to take advantage of cheaper valuations in times of stress.