Notes on Coronavirus and Market Volatility

Below is a commentary I wrote about in Faith and Finance about this time last year that is highly relevant to my notes on the virus here. I share this to frame my advice in the succeeding section of this article:

Researchers believe that the reason for the behavior gap (between professional investors and individual investors) is that investors quite literally lose faith in their portfolios at the wrong times. They later gain conviction in the market at the wrong time. Instead of “buy low, sell high,” investors too often do something close to the opposite. They sell out of despair and buy out confidence in a trend that may be half-way (or more) to running its course already.

My perspective on closing this gap comes from the people I’ve worked with. When I interview clients about why they abandoned their strategy in the past at the wrong times, I was surprised at first when I would hear that they hadn’t understood or believed in their portfolios in the first place!

Much of the time, they didn’t understand what they were getting into at first, and only really started taking a hard look at their portfolio when it was losing money. For some, it made it easier to give up on their investments when times were hard when they realized what they had was never what they wanted.

As someone with a background in currency, commodity, and Index trading, possibly the best advice I can offer on highly distressing market realities is psychological. After all, I believe that most poor investment decisions are not made because of the wrong information. They’re often not made based on information at all. There’s usually an emotional driver behind the big financial decisions we regret most.

My advice is to do a self-assessment throughout the course of this market cycle. If you’re a person who journals, document your impressions of the experience. You can track your level of distress on a scale of 1 to 10 for a simple and easy to implement self assessment. Doing so daily can be a bit daunting- perhaps once or twice a week is best for a start. It can be useful to capture your sentiments as they happen for future discussions with the financial professionals in your life.

It can be really difficult when an Investment Advisor, Insurance Broker, etc. asks you about your sentiment on market volatility years or perhaps decades after the fact in order to give you the best advice. People are generally good at compartmentalizing things and coping with temporary distresses. As a result, experienced advisors recognize that there’s a fair amount of rule of thumb in assessing investor sentiments about risk when there hasn’t been a large market decline for some time.

Having access to information about how you actually felt at the time during negative market cycles is exceptionally valuable for advisors. All of the thresholds of acceptable losses we ask about in the hypothetical are useful and necessary, but the less hypothetical our information is, the better your portfolio will reflect you as an investor. We still do the classic risk assessment process when we have this quality of information for the sake of uniform, Fiduciary advice that complies with prudent practices and regulations. Nonetheless, many of the data-points in those assessments are less abstract when you as the investor have done real-time self assessments before hand.

The bigger point is that if the market sell-off is unbearably painful to you in the moment, it’s likely that your overall strategy needs fine-tuning. As an example within this past month of market volatility, the Barclay’s Aggregate Bond Index has increased 3.22% over the past month, with 1.45% of that coming from the past week. Over the same period, the S&P 500 Index is down 13%. Having the right mix of Fixed Income to Equities for the long run is more important than “getting out” of the market at the right time.

Market sell-offs can be excellent moments to fine tune your strategy with your advisor. Our jobs are not to create the Platonic Ideal of all possible portfolios and tell everyone to use a singular, optimal model. It’s our job to build and manage the optimal portfolio that can be abided through good times and bad.

Sometimes your plan doesn’t reflect who you are anymore because you’ve undergone major changes in your life since it was established. Perhaps it was a bit too aggressive because it’s simply been a very long time since we’ve had a large loss scenario in the American stock market. There’s nothing wrong with checking in with your advisor to fine-tune the plan going forward based on real life experiences. After all, a truly good portfolio is the result of a process. Fine tuning is part of the process even without Bear markets or major life events. In short, it’s ok to have a portfolio that needs to be less aggressive after a stressful event such as a market pull-back! Your advisor should appreciate the valuable opportunity to create a plan that reflects who you really are as an investor, as there is no “right” or “correct” way to be.

You’ve probably noticed by now that I’m refraining from prognosticating on the future direction of markets in the near term. The truth is, neither I nor any other advisor has knowledge of the future. Coronavirus is a large uncertainty with very real risks associated. I don’t want to downplay the risks that it poses in the near term because they are real to the best of my knowledge. I’ve consulted Institutional management from the ETF and Mutual Fund companies I tend to recommend over the past month on multiple occasions, and they’re saying the same thing more or less: the risk is real, along with the myriad of other Equity risks that always exist. Systemic risk is always real, and no amount of diversification eliminates systemic risk despite the fact that diversification typically limits it.

One of the more concerning risks I see personally is the human suffering coming from this disease. Not only do I pray for the victims of this illness- those who have recovered and those who haven’t- I am concerned for the least privileged of our society. There are millions of people who may not become ill or suffer illness in their family who will be deeply impacted by the virus. Quarantines, “social distancing,” etc. are events that will lead to those with no emergency funds or portfolio liquidity to draw from suffering real economic consequences. There are many in our society and other nations around the world that cannot afford to miss one (let alone multiple) paychecks from missed hours at work. This is a good reminder to put excess resources toward tzedakah or charity to organizations on the front lines of economic insecurity.

One thing I will say is that I believe I know what the market wants to see, and I believe this will be important to watch in regards to long-term risk management: Wall Street wants to know what fiscal stimulus will be offered to our economy and the emerging market economies that are at high risk to their health systems. This is the feedback loop of our economy.

It’s not enough to know the impetus (in this case, coronavirus) for large downward market trends. We need to understand the reaction of policy makers, we need to know the process they’re using to make decisions, and we need to know the time horizons they’re operating on. I don’t believe we know yet what the full range of fiscal reactions to Covid-19 the U.S. or International governments are going to have. Absent that information, it’s impossible for any of us to say what markets or economies are likely to do. I expect to revise my market assumptions as this information becomes available. I do believe that at this time, people who are forgetting the critical function that government resources play in market stability are missing half of the script in their prediction making.