JIC Market Update - Frequently Asked Questions

Wednesday, March 25, 2020
JIC Market Update - Frequently Asked Questions

Frequently Asked Questions

How long will this last? How much of the bad news is baked into current market prices?

No one knows for sure, and the facts are constantly changing. The market is volatile in part because investors are trying to calibrate market prices to ever-changing reports about the virus and its impact on the economy and corporate earnings. We are likely to see drastically-negative economic releases in the coming weeks as the shutdown leads to lost jobs, reduced corporate earnings, and falling personal incomes. Historically, the market moves in advance of the economy, so the market could rally before the economy bottoms and before infections peak. It’s impossible to get the timing exactly right, but the stock market has fallen about 30% from the peak, so stocks are becoming more attractive to long-term investors.

Will government intervention make any difference in the near term?

Government intervention will make a difference, and in some ways it already has. The ultimate cost-benefit will take years to understand, but in the short term these measures have made a positive impact. The Federal Reserve has aggressively moved to provide liquidity to the markets and keep them functioning appropriately. It has done this by stepping in as a buyer of an unlimited amount of U.S. treasuries and mortgage-backed securities, in addition to resurrecting several other programs from the Financial Crisis which are aimed at stabilizing bond markets. As an independent body, it is empowered to act swiftly and decisively and has done so effectively in the last few weeks.

Congress and the White House have spent the last week or so hammering out a deal on a massive stimulus effort. The passing of this legislation would provide support for consumers and businesses. However, by itself it may not be enough to establish a floor for the stock market. The details are only now emerging, but in general the stimulus will come in the form of massive loans to businesses large and small, as well as direct payments to certain Americans. To the extent the government can provide support until the virus abates and economic activity begins to recover, this could be a successful program. Again, the overall cost-benefit of these efforts will take years to fully understand, especially as it relates to the federal budget and the national debt.

Is it too late to sell now? Will we just ride things down and hope for a bounce back?

One of the keys to answering this question is clarifying an investor’s time frame. Investors with longer time horizons can take a big-picture view and avoid the temptation to time the market. The dangers of market-timing are real. The market’s best days often occur when the news is still bad and the outlook is still bleak, as we saw on Tuesday when the Dow rose more than 11%, its best day since 1933. Further, the average one-year return from the bottom of the past 12 bear markets is 52%. Investors that are out of the market even for a short time severely curtail their returns and miss out on much-needed rebounds off the bottom.

The other key to answering this question is asset allocation. Investors with the appropriate mix of stocks, bonds, and cash can wait out this bear market without having to sell stocks at low levels. In fact, investors with balanced portfolios will see bonds exceed their target weight as stocks fall, and in many cases a prudent move is to trim bonds back to their target, and buy stocks (at a discount) with the proceeds. The same is true as the market rises and stocks exceed their target weight. Trimming stocks back to their target during bull markets prevents portfolios from becoming overly-exposed heading into a bear market. This process of rebalancing has served investors well through many market cycles.

I’m surprised my bonds aren’t holding up better.  What’s going on?

First, like in the depths of the 2008-2009 Financial Crisis, trading was dominated by a theme of “sell first ask questions later.” But a rush to the exit means market makers are having a difficult time matching buyers and sellers to agreeable prices. Even highly-rated municipal bonds weren’t immune from selling pressure as investors raced to raise cash. It comes down to basic supply and demand: excess supply (to sell) leads to lower prices in the near term, even if the security itself has a solid long-term outlook.

Second, the long-term viability of low-quality bond issuers is being called into question. If a recession extends longer than expected, corporate issuers with weak balance sheets and municipalities with high fixed costs relative to tax revenue (such as pension and health care obligations) may lose their ability to service their debt. This is why we emphasize only high-quality securities with low default risk when constructing bond portfolios.

We are confident that near-term liquidity strains in the bond markets will eventually ease, and our high-quality approach will continue to provide the stability needed for our clients.

Are you repositioning stock exposure to take advantage of any opportunities that now exist?

Volatile markets like the one we have experienced in the last month create opportunities. As stocks have sold off, high-quality bonds have held up much better, creating opportunities to rebalance portfolios as discussed above. A disciplined approach requires the willingness to trim stocks when times are good, and buy stocks when times are uncertain. This runs counter to human nature and requires perspective and the fortitude to stick to the long-term strategy.

This is also true within the stock market when evaluating various types of stocks. In volatile markets there are often significant discrepancies in performance among cap sizes (large, mid, small), domestic versus international, and among sectors, industries, and individual stocks. These dislocations create opportunities to sell stocks that have held up relatively well in the selloff in order to buy stocks that have been oversold and trade at attractive valuations.

Should I cut back on my spending this year? 

There isn’t a one-size-fits-all answer to this question. For some, cutting back while the market is down has positive psychological and emotional benefits, even if they don’t need to do so for their long-term plan to work out. But for many others, a cut in spending is not necessary. This is especially the case if the portfolio has adequate bonds and cash, as discussed above. The key point is to avoid selling stocks at fire sale prices, and allow them to recover. We encourage clients to maintain enough in conservative assets to sustain portfolio withdrawals for three to seven years, depending on their risk tolerance and financial situation. Historically, this has been more than enough. Since World War II it has taken the stock market 17 months on average to return to prior peaks.

For those still working and accumulating savings, now is an opportunity to gather any extra cash and buy stocks on sale. Many have been forced to cancel or postpone plans, and are left with unspent cash in the bank. That cash could be put to use in the form of retirement plan contributions to IRAs and/or 401(k)s, or making additional deposits to taxable investment accounts.

 

 

One of our most important responsibilities to client and prospective clients is to communicate in an open and direct manner. Some of our comments in this presentation are based on current management expectations and are considered “forward-looking statements”. Actual future results, however may prove to be different from our expecta-tions. You can identify forward-looking statements by words such as “may”, “will”, “believe”, “attempt”, “seek”, “seem”, “think”, “expect”, “likely”, “potentially”, “ought”, “try” and other similar terms. We cannot promise future results. Any performance expectations presented here should not be taken as any guarantee or other assurance as to future results. Our opinions are a re?ection of our best judgment at the time this presentation was created, and we disclaim any obligation to update or alter forward-looking statements as a result of new information, future events or otherwise. The material contained herein is based upon proprietary information and is provided purely for reference and as such is con?dential and intended solely for those to whom it was provided by JIC.