COVID-19 has changed everything. The way we live has changed as we shelter in place or quarantine. The way we now work from home, on the phone, or by Zoom is a change for many of us. Many people I know are not tech proficient but have now become “Zoom masters.” The economy has shuttered and the Federal Reserve and U.S. Government have teamed up to prevent the “CoronaCrash” from becoming a depression. The solution seems to offer free money to citizens, companies, states, and municipalities. New trillion-dollar programs rolling out every week will likely put the country in debtors’ prison for the next century.
One thing hasn’t changed, and that is the excessive optimism of investors addicted to the Fed’s market backstop. Defying all logic, markets are marching to new highs from what looked like the edge of the bear market abyss. Fierce bear market rallies like we have seen recently are the norm, not the exception. While they are thrilling to ride, like monster roller coasters at the amusement park, they tend to derail. Investors may find their capital maimed once the bear market downdraft reasserts itself.
The Severity of the CoronaCrash
While everyone hopes the CoronaCrash is over and will rally into a new bull market, the probability is extremely low. The health-driven economic shutdown has caused a cessation of regular supply and demand around the world. The U.S. last experienced a shock to supply and demand simultaneously this intensely during the Great Depression of the 1930s. Though the forced stop to worldwide economic activity is far different than the events leading up to the Great Depression, the fallout may be almost as severe. The quick, powerful, and relatively unlimited action taken by the Fed and government should help the U.S. avoid an economic catastrophe.
Low interest rates, quantitative easing, and fiscal stimulus could provide the foundation for a relatively strong economic recovery and resurgence in positive market momentum but is not likely to develop as quickly as people think. It may take a year or more for people to resume normal living and spending patterns once restrictions are lifted. We should see the damage to the economy as corporate profits dry up and business failures take center stage. CoronaCrash bear market relief rallies provide investors the opportunity to raise cash before capital losses cause irreparable harm. Actively risk-managed strategies can help protect capital from large losses while positioning to take advantage of a tremendous buy-low opportunity that emerges at market bottoms.
Casualties of “Buy & Hold”
We don’t buy into the conventional investment wisdom recommending that investors buy and hold low-cost passive indexing products through significant bear market events. The devastation of losing capital is more destructive than the following bull market runs. If market declines during the CoronaCrash reach 50% you will need twice as much or more return to catch back up. Recent studies confirm many investors don’t buy and hold; instead, they bail and fail when losses exceed their tolerance point.
Let’s examine how several commonly used market benchmarks have fared over the past 20 years in Chart 1. Equities as represented by the mighty S&P 500 Index, had a compounded annual rate of return of 5.6%. If we look at the commonly recommended ‘diversified” equity and fixed income allocation, illustrated by the S&P 500 and Bloomberg Barclays U.S. Aggregate Bond Index blends, we see comparable returns. Unfortunately, the average investor did not fare as well. As measured by J.P. Morgan, the average investor only achieved a 1.9% return. Trying to follow the industry’s buy-and-hold mantra has led investors to sell low as losses exceed their risk tolerances. Then investors buy high after markets have been on the rise for too long.
Chart 2 shows an analysis of bear market declines effect on an investor’s capital base and an advisor’s revenue stream. We hope this analysis shows readers that significant market declines are not worth the lost capital. Buy and hold, or low-cost passive asset allocation is not an effective way to manage wealth for clients.
CHART 2 – Hypothetical Investment Illustration
Source: WBI, 2020.
We believe investors should focus on limiting losses, promoting compounding on a larger capital base over their investing lifetime. Our experience shows the combination of limiting losses while producing consistent returns on a larger capital base tends to enhance capital compounding and investor success rates. We feel the best way for advisors and their clients to survive the economic and market fallout likely to occur from the CoronaCrisis is to prioritize protecting capital now — before it’s too late. It’s time to be heroic as an advisor and fiduciary by shunning conventional approaches we know have not worked well for some investors over the past few decades with successive bear market cycles.
The views presented are those of Don Schreiber, Jr., and should not be construed as investment advice.
Past performance does not guarantee future results. All economic and performance information is historical and not indicative of future results. This is not an offer to buy or sell any security. No security or strategy, including those referred to directly or indirectly, is suitable for all accounts or profitable all of the time and there is always the possibility of loss. You should not assume that any discussion or information provided here serves as a substitute for personalized investment advice from WBI or any other investment professional. If you have questions regarding the applicability of specific issues discussed to your individual situation, please consult with WBI or your chosen professional advisor. This information is compiled from sources believed to be reliable, accuracy cannot be guaranteed. WBI’s advisory operations, services, and fees are in the Form ADV, available upon request.
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