Where are We Now?
The S&P 500 index, a good proxy for the stock market, closed on April 9 at 2,789.82. The index peaked on February 19 at 3,386.15, fell about 34% by March 23, then rose nearly 25% by April 9, using closing prices. We are now down nearly 18% from the February 19 peak.
The March 23 low came the day after New York ordered residents to stay at home. This has been the steepest decline and recovery in such a short time on record. The sudden turnaround was driven primarily by four factors:
- Low valuations to normalized earnings, especially in depressed industry sectors
- Improving outlook for the Coronavirus outbreak
- Massive fiscal and monetary stimulus
- Stabilizing oil prices
For investors watching the value of their life savings fluctuate, it can feel like riding a roller-coaster. However, in a larger context, February 19, 2020 marked the end of a nearly 11-year bull market that rose 358% from its previous low closing price on February 27, 2009. Despite the recent volatility, most long-term investors have prospered by investing in the stock market.
Investors who panicked and sold during the worst of each bear market missed participating in the subsequent recovery. Although easy to see in hindsight, staying invested while stocks are plumbing new lows can feel unsettling. During times of distress, it’s helpful to remember that long-term economic growth drives company earnings up over time, which, in turn, causes stocks to rise.
Where are We Headed?
We are heading into a very deep recession that will rival the great depression in depth, but hopefully not in duration. Because the government closed major segments of the economy, companies are laying off and furloughing workers at an unprecedented rate. The Fed is forecasting unemployment will reach 32%. Major banks expect the US economy to contract by as much as 40% in the second quarter.
Most economists believe that once businesses reopen, workers will be rehired, and economic growth will ramp up quickly. However, the longer businesses remain closed, the more damage we will see in terms of growing debt burdens, bankruptcies, and dislocation.
Investing from Here
Although everyone’s situation is unique, these are general ideas to consider with modifications for your particular circumstances:
- Cash; Have enough to cover your expenses for 1-2 years, net of dependable income sources, such as interest, maturing bonds, and social security. At current interest rates, US Treasuries are extremely inferior to FDIC-insured bank deposits yielding 1.7% to 1.85% and both have the same backing from the US Government.
- Review your asset allocation versus your target. The most important aspect of asset allocation is deciding on the portion you will invest in stocks (taking risk for long-term growth), bonds (providing ballast while staying ahead of inflation), and cash (providing safety from having to sell when stocks and bonds are depressed).
- Bring your portfolio back to your desired asset allocation. This can usually be done annually, but after large market moves like we had recently, it’s a good idea to do it now.
Market values will typically be the most depressed when uncertainty is greatest. There is a trade-off between waiting for conditions to feel more comfortable and having a chance at investing when markets are close to a bottom. No one knows for certain when the market has reached the low-point in any cycle because no one knows what news will be coming in the future.
Stock valuations depend on future earnings potential of the companies they represent. A major decline in 2020 earnings shouldn’t decimate the value of a company whose earnings will return to normal from 2021 onward. The greatest fear is that some companies won’t have enough cash and borrowing capacity to survive, potentially taking the value of their stock to zero and their bonds to a fraction of their face value. As a result, the biggest concern now is the amount of time the US economy will remain closed.
Investments that will survive the crisis include businesses whose operations are impeded little by current conditions (e.g., Amazon, Walmart, Verizon) and businesses with strong balance sheets (e.g., Apple, Google, Check Point Software Technologies). Because selectivity is especially important now, active investments may perform better than passive indices.
If your income is depressed during 2020, especially while required minimum distributions are suspended, you may want to consider doing a “backdoor Roth” conversion of qualified assets into a Roth IRA account. Converting now will allow your assets to grow and be withdrawn without taxes, but comes at the cost of paying income tax on converted assets at your current marginal income tax rate. Consult with your financial adviser and tax accountant to help you evaluate the opportunity.
Finally, you may want to revisit (or create) your financial plan to help inform your decisions. Doing so can make you feel more comfortable, knowing how your spending levels compare with your resources. Being in good health is more valuable than any amount of money, so take good care of yourself!