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Scott Kays, CFA, CFP®
March 3, 2020
The coronavirus, and the fear of its potential impact on the global economy, has roiled the financial markets. Domestic stock indices were down double digits last week, followed by a massive rebound yesterday. 10-year Treasury yields briefly touched a record low yesterday morning, as money flowed into safe haven investments, before staging a strong rebound during the day. While the economic impact of the virus pales in importance to the loss of life it has caused, the economic impact is not insignificant and needs to be addressed.
We have received a few calls from clients asking what we plan to do with investments due to the coronavirus. The implied question is: “Do you recommend we sell investments to avoid a market downturn?” The short answer is no.
What is an appropriate response to the virus and its impact on the financial markets? There is a saying that history never repeats itself, but it often rhymes. While past volatile markets do not give a perfect guide on how to respond to every crisis, there are lessons we can glean from similar past markets that can help guide our thinking.
At some point last week, the strength of the selling seemed to disconnect from the fundamentals of what is actually happening. Why does this occur? Two primary reasons – 1. Investors simply panic and began selling indiscriminately, and 2. Program trading.
Regarding investors panicking, it is almost always a mistake to sell into a panic. Warren Buffett stated “be greedy when others are fearful, and fearful when others are greedy.” Generally, our primary response to panic selling is to look for potential buying opportunities. For instance, there may be a company we have wanted to buy, but its price has been too expensive. Panic selling often results in stock market bargains. We also used the drop in prices last week to put cash to work from new investors.
Regarding program trading, many large investors set algorithms in their computer systems to sell when the stock market declines to a certain level. This puts additional downward pressure on prices, which triggers other algorithms, and the selling cascades, exacerbating the downturn. Frequently, buying algorithms kick in at some point, and the rush to the exits turns into panic buying, resulting in a huge whipsaw effect. None of this is based on fundamental investing. While program trading can create excessively volatile markets in the short term, in the long term, fundamentals normally win out. Trying to time the ups and downs of the market is impossible, and plenty of research indicates that investors who attempt to do this underperform those who stay the course by a significant margin over time.
A company is worth the sum of the future profits it will generate, discounted to a present value. Only a small portion of the value of a company depends on the next quarter’s, or even the next year’s, profits. As disciplined, long-term investors, we have to ask ourselves what will be the long-term impact of the coronavirus on the global economy. If history is any guide, the impact will be relatively short-term, and it should not have a dramatic impact on the fair value of the stock market.
We have long advised that investors keep five years (at a minimum) of withdrawal needs in fixed income investments. When (not if) the stock market experiences large declines, this should keep you from having to sell stocks at depressed values to raise cash. Following this advice gives investors the luxury of being able to wait several years, if necessary, for stock prices to rebound before needing to sell equities to raise cash. The time to plan for these downturns is before they happen, not in the middle of a panic.
In short, we believe it is a big mistake to try to time the ups and downs of the market and to sell into a panic like this. Stocks often rebound from panic selling with such ferocity that those who sold at low prices often miss out on the gains that ensue before they can get reinvested. Just like nobody could have predicted the double-digit losses of last week, nobody could have predicted the 4 ½% rebound yesterday. Our advice is stay the course, continue executing the investment plan we have prepared for you, exercise discipline, and don’t fall prey to panic.
If you have any questions or would like to discuss your situation with your advisor, do not hesitate to email or call us. We value your relationship and are here for you. Thank you for your trust.
Scott Kays, CFA, CFP®, is President of Kays Financial Advisory Corporation. He can be reached at (770) 951-9001 or at firstname.lastname@example.org.
This report and Mr. Kays’ comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any investment and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned here in.