Wow! No other word seems a more appropriate expression for what's happened to financial markets in the past six weeks. The S&P 500 stock index is currently down almost 27% from its high on February 19th. Small cap stocks in the U.S. are down a whopping 38.7% as measured by the Russell 2000 index. These are staggeringly quick declines considering that prior to quarantining measures in response to the COVID-19 outbreak our economy was in its best shape since our nation's founding.
It's true the stock market was overvalued coming into February and because of that fact client portfolios at our firm were invested at Risk Numbers below each client's target Risk Number. In other words, accounts were more conservatively invested than target. This meant more bonds and less stocks in portfolios than would be the case if the stock market was fairly valued or undervalued. Under normal circumstances, i.e. a general economic slowdown and a reasonable decline in stock prices, the prices of bonds in client portfolios would normally hold up well and serve to buoy account values during the decline of stock prices. Unfortunately recent weeks have not presented "normal circumstances".
From its peak on February 19th to its trough on March 23rd, the S&P 500 dropped 35.4% in just 4 weeks! The Russell 2000 dropped 43.3% during the same time. The speed and depth of the drop caused a "run on the bank" where everyone was selling anything and everything in order to raise cash, and this includes their bonds. It smacks of the dramatic scene in It's A Wonderful Life when shareholders of the Bailey Building and Loan all wanted their money out at the same time. Remember this?
In such stressed times, much of the selling of sound investments is out of fear or forced due to margin calls on investors. They're forced to sell investments at any price and consequently even bond prices, the "safe" investments in our portfolios, can drop to fire sale prices despite nothing being wrong with the bonds themselves. Unfortunately, these fire sale prices are reflected in account values and on account statements. Keep in mind though, these prices are temporary and are not locked in unless the investments are sold at these silly prices. If bonds and loans are held until maturity, they will pay off 100% of their face value barring any real financial problems with the company.
Here's an example of what happened to bond prices due to recent fire selling.
That's a chart of an investment grade floating rate short-term corporate bond ETF (exchange traded fund). It is one of the most conservative investments in our client portfolios. Note how its price is consistently stable over time, and yet the recent "run on the bank" caused people to sell these perfectly safe investments at absurd prices in recent weeks. It was simply a matter of people panicking or being forced to raise cash rather than anything wrong with the investment, and because nothing is wrong with the investment its price will recover to previous levels.
We have to put up with lousy investment values for the month of March, however it will pay to stay the course understanding that these outrageously low prices are temporary. In fact, they're a great buying opportunity for those with money to put to work. We all know the current crisis will pass, just as all previous crises have done. And then asset prices will head higher and even reach new highs in the not too distant future.
The actions taken by the Federal Reserve and Congress in recent days are injecting a tremendous amount of money into the economy. It's our opinion that they're actually overdoing it, and that when this crisis is over there will be too much money chasing too few financial assets. That will take the stock market to new all-time highs and eventually to bubble levels once again. For clients for whom it's appropriate, now is the time to cautiously increase allocations to good, quality stocks for the eventual increase in prices. After prices have hit new all-time highs and begin to look expensive again (likely in 2021), we'll then reduce exposure to stocks significantly. It's this approach that has warranted many of the transactions in client accounts the past few weeks. As markets settle down, you'll see the number of transactions in your account(s) decline because any repositioning will be complete.
It's important to note that we are watching, evaluating and managing your investments every day and every hour the markets are open. Rest assured action is taken only if it can benefit your account by either improving risk exposures or better positioning for future investment returns.
As always, please reach out to us if you have any questions or concerns about your investments. However, due to anticipated high demand from clients for conversations, it would greatly help if you schedule a time to talk. You can do so by either calling our Office Manager, Michelle Campbell, at 209-920-7477 or by booking a call or meeting (face to face or online) directly on our calendar at: https://go.oncehub.com/BluePrintInvestments
Thank you for your continued trust and confidence. We'll continue to work hard for you to deserve it!