[0:00] – Coronavirus and its effects on markets
[4:16] – Investor responses to the coronavirus
[6:10] – What the recovery may look like
[10:50} – The value of diversification and bonds
[12:39] – Peter Mallouk’s tip of the month
[13:00] – Jonathan Clements’ tip of the month
Jonathan Clements: Hi, this is Jonathan Clements, Director of Financial Education here at Creative Planning in Overland Park, Kansas. It is March 2nd. Sitting here with me is Peter Mallouk, President of the firm, and we are Down the Middle. Peter, we could talk about anything these days, but nobody would pay any attention unless we were talking about the one topic that is on everybody’s mind. Coronavirus.
Peter Mallouk: Yes.
Jonathan: So, Peter, what should people be doing?
Peter: So, what’s going on and what should people be doing are two very different things? So, I’ll start with what we see is going on. You basically do have a pandemic. It’s gone from country to country, and there’s mortality risk with it. So, depending on what you want to believe, around 1% of people who have it die. But I think what we also know, just for some perspective, is that most of the people in that 1% are older and have another health illness already, whether it’s cardiovascular disease, diabetes, or something more serious than that. So, it’s really, it’s like a very strong flu.
We also know that as pandemics unfold that the data tends to come downward in terms of mortality rates because we’re basically looking at mortality rate and going, of the people we know have coronavirus, what percentage of them are dying? But we are already discovering that most people who have coronavirus don’t even know they have it. They just think they have the common cold; they’re not going to get checked. So, we don’t really have a right numerator denominator to figure out the math. I suspect when this is all said and done, we’re going to find it’s considerably less than 1%.
But what we do know is it spreads very easily, and something that spreads very easily could hit tens of thousands, if not hundreds of thousands, if not millions of people, and become a real big issue. Now, the market has reacted very negatively to this so far. It’s dropped between 12 and 14% depending on where it is this very minute. Now, in and of itself, that really is nothing. On average, the market every year goes down about 14% from its high, every year. This has happened 50 plus times in our history, and we know how all 50 to 100 plus times ended. The market recovered and went on to new highs. This is a question of when is that going to happen? In the meantime, people collect their dividends.
But is the market completely irrational? I don’t think it’s completely irrational because the market is based on future earnings, not earnings today, but anticipated earnings. And let’s just take Royal Caribbean Cruise Lines. The stock is down 33% over the last few weeks. Is that irrational? Well, I think their earnings are going to be down. Less people are going to book a cruise anytime soon, and then it’ll take them a little while to come back, but make no mistake, people are going to be cruising at some point in the future again, and I think that’s a microcosm for the greater economy.
It’s a global economy. A lot of companies get products or parts of products from China, and some of that’s been disrupted, and when you disrupt that, it impacts earnings. Apple announced over the weekend that they expect their earnings to be impacted by this. Microsoft expects their earnings to be impacted by this. So, the market is basically going down on the idea that well, future earnings will be a little less.
Now, why is the market not down 50%? It’s not down 50% because it thinks this sorts itself out. Hey, at some point this is going to sort itself out. We don’t know if it’s going to be in May. We don’t know if it’s going to be July. We don’t know if it’s going to be a year from now, but at some point, it’s going to sort itself out. And on the other hand, the fact that we don’t know is the definition of uncertainty. And we all hear that the market’s driven by fear and greed, and fear is really another word for uncertainty. And if you’re waiting, if you’re sick and you don’t know what you have, you tend to be a lot more scared than even if you get bad news and at least know what you’re going to do about it. So, the market does not know what’s going to happen, and that uncertainty is what’s creating the fear that’s making the market more volatile than normal, where it tries to find its bearings.
Now, to your question. Boy, how is that for preface, by the way? To your actual question of what is an investor actually supposed to do? What an investor should do is the same thing they do in every correction or bear market, what they should not do is go to cash and wait it out because if they go to cash and wait it out, the market doesn’t wait for things to stop and turn around. No one sounds a trumpet and declares coronavirus is no longer a threat.
What’s going to happen is the market’s going to anticipate that it has resolved itself, and it’s going to go up before there’s a resolution. We see markets recover before things sort themselves out. So, if you go to the sideline to wait and try to come back in, it’s just not going to work. I’ve been doing these 20 years. I’ve never seen that happen with anybody. Of the tens of thousands of clients, we have and prospective clients, I’ve never seen anybody in my career navigate any of the great corrections or bear markets by going to cash the right time and going back in.
But there are things an investor can do. This is a great time to opportunistically rebalance, assuming your portfolio allows it, or it makes sense to be doing that. If you happened to start investing right before this started, and the stocks were supposed to be 80% of your portfolio, and now they’re 62%, buy more stocks. Rebalance right now. Don’t wait for the end of the quarter of the year. You might have missed your opportunity.
If you happened to invest right before this and you have taxable losses, tax harvest your portfolio and sell one S&P 500 fund and go buy something similar but not the same and put the loss on your tax return. So, there are things that a smart, disciplined investor can do to take advantage of any correction including this one, and those are some of the things they should be thinking about.
Jonathan: I think coming back to your example of Royal Caribbean and the fact that that stock is down 33%, I think that’s actually a great example, not just of fear, but also to think about what the recovery looks like, because what we are seeing right now is pure fear. The fact is people may not want to get on that Royal Caribbean boat right now, but that boat is still going to be there six months from now. It’s still going to function as well then as it does today.
It’s not like the global economy is being permanently impaired by this pandemic. The economy, once we have a vaccine, once the fear dissipates will be back at full strength in relatively short order, factories will still function, office buildings can still be occupied, Things will go back to normal very quickly once we get this under control. The growth potential of the global economy has not been permanently impaired by what’s happened with coronavirus.
So, I think that’s an important thing to keep in mind. You go back to September 11th, as horrifying as that also was, the same was true. We saw a small number of buildings destroyed in a horrific way, but the global economy was not permanently impaired, and we did recover from that extraordinarily quickly and it will happen again this time around.
Peter: Yeah. It’s always hard to talk about these things because people are dying. So, obviously it’s a serious thing. I just wrote my first newsletter without jokes, I think, in a decade because some people… Obviously it’s a serious thing, and it can result in a cocooning effect, much like 9/11 where people really do temporarily suspend their demand for things, like going to the movies or going to Chipotle. But the economy, it is actually at its core, very simple.
People want stuff and as long as people want stuff, there will be people that create companies to deliver the stuff, right? It’s just supply and demand, and corrections often come from a suspension for a period of time, of a lack of demand. If this winds up being in every major U.S. City, and we start to see hundreds of deaths, are less people going to go to Chipotle? Yes. Will less people go to AMC theaters, go to the movies? Yes. Will as many people go to the NCAA tournament? Probably not.
If this keeps getting worse, it will be temporary, but are people going to go to the NCAA tournament a year from now or two years from now? Are they going to go to Chipotle when this passes? Are they going to go back to the Apple store when this passes? Of course, they are. It’s common sense.
There’s one other factor that I think is very real, and that is anytime we go through a correction or a bear market, there’s usually one big factor. We talked about coronavirus, 9/11, we’ve had Ebola, the Greek debt crisis, inverted yield curve. There’s a long list of Brexit of stuff that we can point to for a correction, but what happens during a correction is the Federal Reserve will try to do things to encourage people to go about their business to soften the blow.
For example, the market right now is pricing in a close to 100% chance that the Federal Reserve is going to lower interest rates. Now, those are basically bullets in a gun, and the Federal Reserve is using those bullets. And the reality is the market as it was before the coronavirus is very dynamic. So, while we’re short-term suffering, and we know it’s a short-term deal, if this deal lifts, you get what we call a V-shaped recovery. Things come back as fast as they went down. But sometimes you get into a self-fulfilling situation where if something goes on for long enough, and you add something else to it, like you add a terrorist event to this, or you add rising unemployment numbers to this, you wind up with a different reality that’s attributed to the wrong cause. Right? But it’s a piling on of events.
If we look at this, this market correction is due to the coronavirus. If we lift this concern, if we start to see a change in the pattern, a declining of people infected, the market will have a V-shaped recovery barring all the other million things that impact the market, and that’s something an investor should keep in mind too.
Jonathan: So, Peter, you mentioned three things that investors can do right now. One, they can rebalance their portfolios. Two, they can harvest any tax losses, which will reduce their taxes in 2020. And then three, if you’re a regular contributor to the market, you should keep on investing, in fact you can even step up the amount that you invest on a regular basis to take advantage of these lower prices.
I would just throw in two other things that people might think about doing right now. One is they should appreciate the value of being diversified. In the run up to February 2020, we had a lot of nonsense being talked about, “Oh, there’s no need to own bonds. Oh, all you need to own our technology stocks.” Look at what has happened. We’ve discovered the value of having a broadly diversified stock portfolio. If you had been, say, heavily weighted to towards energy stocks, you would’ve suffered mightily so far this year. If you’re in total market index funds, and you own all those sectors across the U.S. economy, you’re in much better shape in all likelihood, than if you were focused on just one narrow sector.
And two, bonds have done their star turn as they always do at these times. If you’ve been in high quality bonds and especially treasury bonds, they have helped to salvage your portfolio’s performance over the past week. So, people should ignore all that nonsense about, “Oh, you shouldn’t own bonds for diversification.” Yes, you should own bonds.
And the second thing that people will learn from this decline is what their true risk tolerance is. A lot of people became overly aggressive through the latter part of the 2010s. As the stock market kept rising, they started keeping more and more in the stock market, and now they’re probably having a few queasy moments, and you should learn from that. You should have a portfolio that you can live with through a market decline. Living with it through a rising market is not enough. Today, you are learning what your risk tolerance is and take that information and use it and build it into your portfolio going forward.
Peter: Yeah, last week was the first week in a long time no one emailed me asking me why they owned bonds. So, I would concur. I would concur with that.
Jonathan: All right, Peter. Well, I think we probably talked about enough about the coronavirus, at least for today. So, it’s time for the tip of the month. What have you got for us, Peter?
Peter: So, in line with what you could be doing now that would be constructive and helpful to your financial situation, I would tell our listeners to look at their debts and see what they can refinance. Rates have dropped yet again. So, if you’ve got a mortgage, this is the time to shop that mortgage and see if you can lock in a lower rate and to look at all of your debts and see if you can refinance to lower rates.
Jonathan: And for me, Peter, my tip of the month is to ask yourself one simple question. What would your future self-think? It’s a question you can ask in almost any situation. If you’re out at a bar at night, and you’re thinking of having an extra drink, ask what your future self, the one who will wake up tomorrow morning, will think about that extra drink. Think about it before you have that fourth slice of pizza, and when it comes to financial markets, ask what your future self will think. If you give up on the stock market today, what will your future self, the person you will be five years down the road, think about that decision. In all likelihood, your future self will regret your current self for being so foolish.
Peter: As somebody who literally, just yesterday, had one too many slices of pizza and maybe one more drink than I should have had, I concur greatly with that advice.
Jonathan: So, anyway, that’s it. That’s a wrap. It is March 2nd. We are here in Overland Park, Kansas. It’s me and Peter Mallouk, President of Creative Planning, and we are Down the Middle.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment, tax, or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed to be reliable but is not guaranteed.