Searching for Clarity amid Market Volatility
SEARCHING FOR CLARITY AMID MARKET VOLATILITY
South Florida Business & Wealth
By: Kevin Gale
April 21 2020
Markets have completed a round trip since mid-February when the Coronavirus pandemic started to spread around the globe. The U.S. equity markets fell over 30% from their highs in record time and found a temporary bottom on March 23rd. Massive government intervention on the fiscal and monetary front plus less bad news on the virus trajectory ignited a strong rally taking markets up over 20% from their March 23rd lows. We are far from previous market highs and will now begin to face the economic data that will shed light on the reality of the economic downturn while investors search for clarity on what to do.
Below, are some initiatives investors can tackle now as we move forward.
Stay Diversified: Diversification is the only free lunch in portfolio management and now more than ever should be prioritized above all else. The sudden market drop exposed some of the most vulnerable companies in industries like energy, travel, leisure and others. Long-term investors need to be diversified among geography, industry, sector and company in order to mitigate risk and avoid portfolio destruction by being heavily allocated to any one sector or industry.
Time for a Quality Upgrade: In 2019, investors were spoiled with investment returns that were historically above average, which led to investors becoming more complacent and having less appreciation for risk. We have been shown, once again, that market selloffs of an extreme nature tend to expose the most vulnerable of portfolio allocations. All bear markets have different outcomes and time scales but the action of financial markets during these episodes is reasonably consistent. An extreme panic drop is usually followed by some relief rally that can be swift and substantial. We are currently in the relief rally phase giving investors a window of opportunity to make adjustments. This is an excellent time to review your portfolio and upgrade the quality of your holdings. This exercise would entail eliminating strategies that experienced more downside than originally assumed and using the proceeds to reinvest towards areas that are able to withstand further market volatility and provide participation during an eventual recovery. For example, in the energy sector, reducing exposure to heavily indebted middle market players in favor of large-cap diversified conglomerates with stable balance sheets is one move that can be made to enhance the overall quality.
Fixed Income Securities: Fixed income was not entirely immune from the market selloff as credit spreads widened for a brief period in March. There was a stark difference in performance when comparing treasuries to corporate bonds during the depths of the selloff. Historical monetary measures implemented by the Federal Reserve calmed the credit markets causing temporary dislocations to be reversed. Now that calmer seas are at hand, reviewing the quality of your fixed income securities should be undertaken with the same amount of scrutiny as an equity allocation. Diversification among investment type, maturity, geography and tax status are several ways to mitigate volatility within fixed income. The goal of fixed income should be to serve as the ballast in a blended portfolio in order to offset volatility coming from the equity portion of the allocation.
Rebalance and Stay Committed: If the market decline and expected economic slowdown will not significantly alter your long-term financial plan, it is a good time to review rebalancing your portfolio back to its original investment target. For example, imagine that before the sell-off, an investment allocation had a target of 50% equity and 50% fixed income. At the trough of the market lows in March, that original target more than likely shifted to something like 45% equity and 55% fixed income due to natural causes. Assuming no change to a long-term financial plan, reducing fixed income to add to equities at much lower levels is a sure way to stay focused on your original goals and objectives. Rebalancing over time has shown historically to lower risk and provide better returns as opposed to portfolios that are never rebalanced.
Cash is King: Proper financial planning always advocates for a 9-12 month readily available cash balance in place for emergencies. This is vital in the unpredictable market we currently face. With the job market becoming more uncertain as we begin to feel the effects of the virus pandemic, Americans will need to be extremely budget conscious and prudently plan for the necessities vs. wants in a typical household budget. Having a cash balance that satisfies 9-12 months of necessities avoids the problem of selling securities in a down market. Having a cash balance comfortably tucked away in a bank account or high-quality money market will avoid the need to sell otherwise high-quality investments at inopportune times.
While these are no doubt unprecedented times and many investors are apprehensive due to constant doses of unsettling headlines, policymakers around the globe are taking swift decisive actions to mitigate the virus itself and its economic effects with extraordinary monetary and fiscal stimulus measures. In summary, during periods of extreme market volatility, stay diversified and focus your attention on what will perform best as the economy recovers in the future; analyze your fixed income allocation for quality issues; and take advantage of market calm to rebalance.
We can never perfectly predict and prepare for outlier events like a virus pandemic but staying vigilant and assuming risk can arise at any time is prudent thinking.
May you all stay safe and healthy.