Happy New Year! 2020 turned into a year like no other. Amid the Covid-19 pandemic, it proved to be one of uncertainty as well as resilience, and in the world of wealth management it was akin to a rollercoaster. Below is a reflection on some of the lessons we learned this past year and explore some of the recurring themes we noticed during times of market volatility. As we share our learnings below, there are a few things to keep in mind about the market volatility we experienced in 2020. First, this recession was caused by exogenous factors, a product of an impossible-to-predict health crisis and self-imposed restrictions. Therefore it is unlike the global financial crisis and prior recessions that stemmed from endogenous factors. But while many lessons are unique to this crisis, we believe the ones listed below capture some of the takeaways that can be applied in future bear market corrections.
Time in the market vs. Timing the market
The age old saying goes something like this: “It is time in the market that matters, not timing the market.” The strategy this phrase highlights is the one of buying and holding, moreover, capital accumulation through compounding – using money to make money. While the buy and hold strategy might work for most investors in the long term, as an investors’ time horizon changes and need for capital preservation increases, this idea is thrown into question. As we saw with the pandemic, when capital is impaired, it takes time to get it back to its original balance and then additional time to grow it from there. If an investor was at the twilight of their investing years, the losses would be disproportionately more painful as they would have less time to recoup. It is difficult to compound the principal if it is broken, especially if the investor’s time horizon is shorter. Time in the market matters, but avoiding permanent capital loss and protecting your investments are still key pillars to sustaining portfolio balances.
Don’t have a plan? Stay put.
In the previous section we delved into the idea of preserving capital. But when capital is impaired, do you just leave? Not necessarily. There needs to be a clear set of rules that govern your return to the market. Let’s take an extreme example – imagine selling an equity position as it slid to its low point. What can the cash be used for? Should a new position be added? What’s the true opportunity cost of selling? There are two reasons to stay put in high quality names: 1) it gives the opportunity to capture the recovery when the economy gets back on its feet; and 2) it might be more expensive when trying to get back into the market. As an investor, there should be conviction in the quality of the portfolio holdings – balance sheets, business models – and going over these items can help reduce anxiety during periods of market stress. It is important to comprehend why market prices of individual securities in portfolios have given up their gains for the year, but more importantly to understand the catalysts ahead that will help the portfolio recover and grow. Unless it is a clearly outlined plan, it is better to stay put than to panic sell. The urge to take action, any action, during periods of intense volatility can be incredibly powerful. Yet sometimes, the hardest and the right thing to do is precisely “do nothing and follow the investment plan/process”.
Do something? Do nothing?
Being disciplined is a sought after trait when it comes to investing, but so is being patient and opportunistic. Doing something, as much as it is challenging, can also be the most rewarding during volatile periods. Using cash and fixed income to get into high quality names when they were at their lows in early spring and opportunistically rebalance would have enhanced overall portfolio returns this year. On the other hand, allowing outsized asset mix drift away from strategic weights and holding on to names that did not fare well, even in the recovery, came at an opportunity cost. Recessions and bear markets are features of investing. It is not the bear market that matters, but what we do (or don’t do) during bear markets that are going to have the greatest impact on long-term portfolio outcomes.
You control the volume
One of the best ways to maintain discipline in all markets is to have a diverse array of research sources as the loudest voice, at any given moment, is often the one that has been recently validated. In the depth of the sell-off in mid-March, pessimistic viewpoints were amplified. Many of these same investors had accurately warned of risks in the months prior to the sell-off and deserve plaudits for that, but prognostications of doom made after a large market drawdown has already occurred are akin to a TV reporter warning of an incoming storm while trees are snapping in the background. Ultimately, prognostications of doom in March were no more prescient that the chorus of bullish views expressed in the media blitz at the World Economic Forum in Davos just two months prior. One participant even went as far as proclaiming ‘the end of the boom-bust cycle’ just months before the swiftest end of a cycle we have ever seen. This is not intended to be a “freezing cold takes” exercise, but to underscore the importance of consuming information from multiple viewpoints to help balance the amplification of views that price action can produce. The extreme swings in sentiment experienced at multiple points in 2020 highlights the value of seeking out non-consensus viewpoints and understanding both the bull case and the bear case. This is particularly important when the consensus drifts in the same direction towards any of the biases that virtually all investors carry.
The value in building safety into portfolios, then opening the safe in an emergency
A lot of investors have questioned the value of holding lower yielding fixed income and cash equivalent securities in the fixed income part of the portfolio, but these securities proved their worth in providing ballast to portfolios this year. The value of this allocation showed up in the form of smoothing volatility at a portfolio level. Additionally, it provided a valuable funding source to satisfy potential liquidity needs to fund opportunistic investments. It gets harder every year at lower and lower yields, but the value of these positions is not about yield, but rather the optionality they build into portfolios. High-quality bonds and cash equivalent securities have proved time and time again that they can help buffer large declines in equities in a multi-asset portfolio and serve as an “emotional” hedge for investors.
Economy does not equal the Market?
The markets and the economy don’t always align. The S&P 500 bottomed on March 23, rebounded to its February 19 high by mid-August, and finished the year at a record high. Meanwhile, there are still around 10 million fewer employees than before the pandemic and U.S. gross domestic product is expected to contract -2.7% in 2020 (consensus forecast). While there does seem to be a disconnect between U.S. equities and U.S. economic output, if you were to de-construct the market (i.e. take out the dominant names), that gap narrows. The five largest constituents of the S&P 500 – Apple, Microsoft, Amazon, Facebook and Alphabet, returned between 30.8% and 82.3% in 2020. If you didn’t own a handful of those top names, you may have underperformed the market. The S&P 500 minus these five stocks returned 10.8% over the same period. While it can be easy to look at the market and the economy side by side and say they are not equal, the constitution of the market and where you see the most weight can sway that narrative. It is also good to remember that equity markets bottom when all hope seems lost and before the real economy bottoms; most economic indicators are backward looking, and markets are forward looking.
Needless to say, many of us want to forget the rough ride that was 2020 and move on to 2021. However, as hard as it may be to relive, we encourage you to take a step back and see what your learnings have been in a year that will go down as one of the most tumultuous in recent memory.
Should you have any questions, do not hesitate to reach out.