Author - Prashant Vaishampayan

Jonathan Clements writes on his blog that today’s economic problems won’t lead to nuclear war. But many folks seem to fear the economic equivalent: that we’ll suffer a downward GDP death spiral that sends us back to the Stone Age. Let’s face it: If the economy ceases to function, it won’t matter what you own. What if the economy recovers, which everybody—except your crazy uncle—expects will happen eventually? Stocks will go up.

In other words, owning stocks is an asymmetrical bet. As with bonds and cash investments, the most we can lose in the stock market is 100% of our investment. But with stocks, your potential gain is far larger. In fact, it’s infinite. To be sure, we haven’t yet reached infinity but we’ve been doing pretty well.

True, there have been periods—like today—when you would have been better off avoiding stocks and instead of going long cash, hand sanitizer and toilet paper. But these periods typically don’t last more than a year. Indeed, to profit from a stock market downturn, you need to be right not only about the direction of share prices but also in your timing.

History tells us that almost nobody is consistently smart enough or lucky enough to succeed with such bearish bets. That leaves the rest of us to do the sensible thing, which is to play the lopsided odds offered by the stock market’s asymmetrical bet. Over time, we should allocate as much as we prudently can to stocks, knowing that we’ll suffer occasional rough patches, but also knowing that the stock market’s long-term direction is up. That doesn’t mean we should stash everything in stocks. If we have money in our portfolio that we’ll need to spend soon, that should be in conservative investments, so our spending plans aren’t derailed by plunging share prices. Similarly, if we’re nervous investors, we might keep more in bonds, so our portfolio’s short-term performance is less erratic.

Clements doesn’t know which stocks will fare best in the months and years ahead. Some companies—both privately held and publicly traded—will never recover from today’s economic shock. Indeed, with any single individual stock, we could end up on the wrong side of the asymmetrical bet and lose 100% of our investment. Even entire national stock markets (hint: Japan) can struggle for decades. But those who bet on the global stock market for the long haul have never lost 100%. For these investors, the asymmetrical bet has always been a winner. After every stock market decline, share prices globally have recouped their bear market losses and then headed higher. Every single time. Want this upward trend to be your friend? The formula is very simple: Buy stocks. Diversify broadly. Wait patiently.

Stephen Clapham in his blog behindthebalancesheet.com has come up with ten reasons why the investment landscape in the western world will be different in post-Covid19 virus world. His points are worth pondering over by all investors. This article contains reasons number 6-10.

6. WHERE NOW FOR INCOME FUNDS? For many companies, the priority will be rebuilding balance sheets. Dividends will be a secondary issue. For those companies subject to Government rescue, dividends are likely to be capped or forbidden until debts are repaid. Income fund managers will have an increasingly narrow repertoire. A corollary may be that some perennial dividend payers may be rerated as these funds are forced into a narrower group of stocks.
7. FINANCIAL REPRESSION & CAPITAL CONTROLS One clear effect of the pandemic is that almost every government on the planet will have a lot more debt than they did in January. And the situation in January was not looking particularly attractive. My guess is that Governments will at some point feel constrained in what they can spend and they will seek to reduce their debt burdens. Most will surely be forced to (continue to) engage in a policy of financial repression so that their interest rates are below inflation. The best way of reducing debt to GDP is higher growth – timely fiscal stimulus should be a priority for all Governments, and correctly delivered, gets us all out of a mess.

8 BALANCE SHEET RESTORATION Personal and corporate balance sheets need to be restored. This is likely to weigh on economic growth for a number of years. Companies will likely rein in capex for the 2020-2022 period. Consumers will buy fewer and cheaper big-ticket items. This seems inevitable, although the impact is hard to model on corporate earnings at this point – we do know, however, that earnings will be lower than formerly forecast. The one slightly odd exception to the big-ticket expense may be the leisure sector where there will be a massive pent-up demand for holidays.

9. RIPPLE EFFECTS AND INFLATION The coronavirus crisis has created huge, survivability issues for a limited number of sectors, notably airlines, travel and hospitality. The duration may be variable. These have been fairly obvious and direct impacts. What we have yet to understand is the indirect impacts beyond the general economic decline. My candidate for the most impactful would be an increased propensity to save which would slow economic growth.
10. The Great Reset: In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the embezzlement increases rapidly. In depression, all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. Now finance chiefs have an opportunity, presented by the virus, to engage in the Great Reset – earnings will be reset, the virus will be the excuse. Even if there were no lasting effects from the virus, earnings for the vast majority of quoted companies would be reset down. They have been stretching the elastic of earnings for some years and now they have the opportunity to get their books in order. Forecasts will go down, even before you factor in the virus effects.

Stephen Clapham in his blog behindthebalancesheet.com has come up with ten reasons why the investment landscape in the western world will be different in post-Covid19 virus world. His points are worth pondering over by all investors.

1 Fortress balance sheets: One legacy of the pandemic may be a culture of greater conservatism and risk aversion. Boards are likely to adopt a more conservative approach – the shock we have just experienced will make even the less risk-averse Director appreciate having more cash and more facilities, just in case. Boards will likely want some security against another pandemic.

2   Onshoring supply chains: Businesses are likely to shift to from lean ‘just in time’ to bigger ‘just in case’ inventories. Businesses will be warier of single sources of supply or demand, allowing for a greater ability to switch activities or locations. Clearly there is an associated cost. The risk inherent in just-in-time and diverse supply chains has become more apparent and companies will surely want higher stocks, more diversity of supply and will onshore more production as a protection against a recurrence. Again this will have two implications: Production costs will rise and Returns will fall as inventory and working capital increase.

3 Working capital unwind: Unwinding of working capital will occur on both sides of the balance sheet. A number of industrial companies which have improved working capital tremendously over the last 10-15 years. But many have done this predominantly by failing to pay suppliers on time – unless their supply chains are extraordinarily robust, these companies will be hit by the need for increased inventory (see 2 above) and by the need to start paying suppliers more quickly.

4  Interest rates may stay low for some time: It seems highly likely that interest rates will stay low for an extended period. Clapham’s base case assumption is that as with the situation post the GFC, inflation will remain subdued (this may well be the surprise of the decade as inflation returns as in the mid-1960s, but not for a while). This should, in theory, continue to fuel the valuation of growth stocks. With growth scarcer, this becomes an even more attractive feature.

5 Pension deficits to increase significantly: Assets have gone down significantly for those with higher exposure to equity, less so for those funds with a larger exposure to bonds and. And funds with heavy exposure to alternatives may find that the lack of a mark to market doesn’t help if the private equity portfolio companies sink under the weight of their dent. Liabilities have gone up significantly because the liabilities are discounted to present value based on bond yields which have collapsed. This means that pension deficits will have increased significantly for most quoted companies. This is almost a straight subtraction from equity values.

We will continue with the remaining five on Sunday 3^rd May.

Charles Schwab built a Fortune 500 company whose value compounded at an average rate of 19% a year since IPO in 1987; twice the growth rate of the S&P500. The customer was at the heart of everything Schwab did. He entered a race that for fear of revenue loss, the large incumbent brokers didn’t want to be involved with, a lucrative niche providing customers with cut-price stock transactions which he exploited and expanded with new technologies. Charles Schwab tells his story in a recent book, ‘Invested – Changing forever the way Americans invest’.

Following are his views on the Stock Market & Investing

“With the stock market, there are no guarantees. You can guarantee service, costs, quality, and certainly integrity. But you can’t guarantee performance; Risk is just part of the deal.”

“I don’t think human nature deals very well with the patience and strong stomach investing requires. We’re wired for fight or flight.”

“I have now seen nine crashes in my life, and it still troubles me that investors react this way [sit on the sidelines], because it always ends the same. The market roars back and leaves too many investors sitting on the sidelines missing out. Sometimes I wish I could just tie them to their chairs to help them ride out the temporary storm. To this day our advice is the same: ‘Panic is not a strategy, stick with your investment plan, and don’t let emotions get the better of you.’ Heeding that advice when you’re in full panic mode is just not easy. People aren’t wired to be good investors.”

“The most natural instinct is to run for the door. To sell. Sell everything,’ I said [in 2008 when reaching out to clients]. ‘You’ve got to fight that emotion because you want to be able to hang on for the recovery. Which has happened every time we have had an experience like this in my career and that goes back now some 40 years … nine different cracks in the market like this. Smart investing is about taking it year by year. It is a little bit of a nightmare, but we handle those by living through them and looking forward to better days.’ Did I get the timing right with my advice? Not exactly. You never do. And that’s exactly the point… Timing the market is impossible. As the saying goes, it’s not timing the market that counts, but time in the market.”

“Successful investing is not easy, that’s the bottom line. It involves so much of your emotions, your sense of self-worth, your ego.”

source: http://mastersinvest.com/

Howard Marks, a renowned investor answers the important question, “Should I wait for the bottom?” In short, the answer is no. Since bottoms are only found out after the fact, buying on the downswing offers more opportunities than the alternative — waiting for some “all clear” signal.

Jon reminds us on his website that the old saying goes, “The perfect is the enemy of the good.” Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones. Think about your normal behaviour. Before every purchase, do you insist on being sure the thing in question will never be available lower? That is, that you’re buying at the bottom? I doubt it. You probably buy because you think you’re getting a good asset at an attractive price. Isn’t that enough? And I trust you sell because you think the selling price is adequate or more, not because you’re convinced the price can never go higher. To insist on buying only at bottoms and selling only at tops would be paralyzing…

The bottom line for Jon is that he is not at all troubled saying (a) markets may be considerably lower sometime in the coming months and (b) we’re buying today when we find good value. He doesn’t find these statements inconsistent.

With as fast as the market’ moved in the past two weeks, the question might be updated to: “Did I miss the bottom?” Arguments can be made for both yes and no. The correct answer is it’s impossible to know today. Besides, not holding tight to opinions on this is more important than having one. Jan –March quarter earnings, over the next few weeks, will offer some insight into the impact. But April –June quarter numbers will tell the tale. The best-case scenario is we won’t find out the real hit to companies — revenues, earnings, etc. — until sometime in July, at the earliest. Duration is still the biggest unanswered question right now. How long will it last? How will the market react to companies that report no revenues for a month? Two months? A quarter?

Investing is about understanding potential risks, placing bets based on those possibilities, but also being prepared for alternative outcomes. That’s why investing is a tradeoff. Finding the perfect balance between attack and defend in your portfolio is never easy. But if you go all-in thinking the market bottomed in an attempt to not miss the recovery, and you’re wrong, then you lose.  But if you’re all-out and wrong, you miss out on gains and also lose. Investment survival is a necessity. So finding a good enough balance, that you’re comfortable with, is key.

Jon concludes that the only guarantee is that when all this blows over, everyone will wish they had more cash to invest, that they bought more stocks, and at a better time. That’s the painful lesson with risk — not all risks are realized but we still need to prepare for it just in case.

Robert P. Seawright writes on his blog that investors have to face fear every day, more so on some days than others. To quote Jason Zweig paraphrasing Mike Tyson, “investors always have a plan until the market punches them in the face.” Every investor got punched in the face during 1Q 2020. Over and over. What’s an investor to do? The obvious temptation is to sell and maybe hide, but betting against the market is a dangerous business. Peter Lynch famously said that more money has been lost trying to avoid bad markets than in the bad markets themselves.

We humans don’t handle the stress well. As Laurence Gonzales explained in Deep Survival, “it’s easy to demonstrate that many people (estimates run as high as 90 per cent), when put under stress, are unable to think clearly or solve simple problems. They get rattled. They panic. They freeze.”

Our quite natural reaction to market volatility, to fear, is to bail. Trying to time the market in that way comes with a crazy-high degree of difficulty. Market-timing successfully means making many immensely difficult and complicated decisions and being consistently right. There is no reason to expect anyone to be able consistently to navigate difficult markets without losses.

On the other hand, staying in the market has significant advantages. Studies concluded that an average of just three days per year generated 95 per cent of all the market gains. Long-term returns accrue in bunches, and, in the markets as in the lottery, you’ve got to be in it to win it (although the market offers an exponentially greater chance of success). Moreover, the majority of the market’s best days occur within two weeks of the worst days (as we’ve seen recently), meaning that if you could somehow avoid the worst days, you would almost surely miss a lot of best days. It generally pays to stay invested.

Trying to “go to cash” at opportune times and, equally importantly, buying back in at the right time, is a loser’s game. Market timing strategies are frequently tried, rarely, if ever, successfully. Stocks are worth their volatility, the necessary price you pay for the much higher expected returns of stocks as compared with other investment choices. Accordingly, the longer the time frame we use for reference, the more powerful stocks become.

That’s why truly long-term investors shouldn’t worry about market volatility, which raises what is likely the crucial question: Are you a long-term investor? Those who recognize that fear will get the better of them might consider a portfolio mechanism like a pressure relief valve to try to help manage their fears. A decent portfolio that you can stick with is far better than a perfect portfolio you can’t. [Quick Check: How often did you check your portfolio last week? If your answer is something like, “A lot,” Seawright may well be talking about you]

Seawright concludes that despite the current turmoil, the difficulties of which should not be underestimated, the probabilities still favour investment. By a lot. Our brains all echo with fearful thoughts, whispers, and imprecations. For most of us, most of the time, we’d do well to ignore them about our investment choices.

Joe Wiggins writes on his blog that it is at times of severe market stress that our worst behavioural impulses come to pass. Whilst the recent losses in the value of portfolios are undoubtedly painful; the poor decisions that we will make as a result of the torrid environment will likely prove more damaging to our long-term outcomes. Against such a turbulent market backdrop, which behavioural issues should we be most concerned about?

Myopic Loss Aversion: Short-term losses are difficult, but they are also an inevitable feature of investing in risky assets.  Indeed, the high long-term returns from equity investment are a consequence of their volatility and the potential for severe losses – to enjoy the benefit you must be behaviorally disposed to bearing exacting periods.  For most investors (particularly younger ones) it makes sense to reframe the issue – rather than markets falling precipitously we should think about the likelihood that long-term expected returns from risky assets are now materially higher.

Recency: Our obsession with recent and salient issues means that they overwhelm our thinking.   Whether it is trade wars, Brexit or coronavirus.   This is not to say that such issues are not important but from a long-term investment perspective they are less vital than we think and feel they are at the time.  Try to make investments on the basis that we have to leave them untouched and unseen for the next ten years.

Risk Perception We are poor at judging risks.  We are prone to ignoring certain threats whilst hugely overstating others.  Our judgement about the materiality of risk tends to be driven by its availability (how aware we are of it) and its emotional impact on us.  The coronavirus is a particularly harmful risk for investors both because the magnitude of the impact is highly uncertain and it is deeply salient.  We also need to be clear about what risks we are considering when making an investment decision – is it the risk of short-term losses, the risk of being whipsawed by volatile markets, or the risk of failing to meet our long-term objectives?

Overconfidence In the past three months everyone has become an expert in virology, despite having no previous grounding in the subject.  It is okay to have an opinion, but the vast majority of people are guessing, and nobody knows the near term market or economic impact of the virus.  We shouldn’t make investment decisions that suggest we do.  In these environments making sensible long-term investment decisions is highly likely to leave us looking foolish in the short-term.  This doesn’t mean, however, we should not make them.  The advantage of being able to invest for the long-term is at its greatest when it is the hardest thing to do.  The only way to benefit from this is to have a sensible investment plan that is clear about objectives and the decision-making process.

This is a summary of a couple of articles that I read over the weekend. Investors all over the world are worried about the volatility and spread of COVID 19 virus. Here are some sobering thoughts.

The Evidence-based Investor website reminds us that crashes and corrections are a feature of equity investing, but when they happen they can be hugely unsettling. At the time of writing, exchanges around the world have rallied after the worst day for markets for 33 years. But don’t be fooled. We could be in for plenty more stomach-churning volatility in the days and weeks ahead.

The problem is, no one can predict the future with any accuracy. It’s impossible to say quite how serious coronavirus will be, or what impact it will have on the economy, let alone the markets. And markets may rise or fall sharply from here for reasons that have nothing to do with COVID-19. Yes, there’s lots of bad news out there. And there’s bound to be more to come. But life goes on, and there should be rich rewards for investors who keep their long-term focus, diversify, control their costs and carry on investing what they can. Stay calm, wash your hands and don’t touch your face. Or your portfolio

Michael Batnick reminds investors that it is hard to stay calm and ignore the movement day after day and week after week, especially if the market keeps going lower. But, when this thing finally does end, there will be a rally so fast and so furious that it will leave the people who sold like a deer in the headlights. They won’t know what to do. The idea that people who sell out of fear will buy out of greed is misguided at best.

Batnick warns us that if you’re making drastic changes to your retirement fund, just stop. There is too much on the line. What you’re really doing is ensuring you’ll have less money in the future because you’re uncomfortable today. It’s OK to be uncomfortable, in fact, it is guaranteed that over the course of your investing life, you will feel this very same emotion half a dozen times, maybe many more. You can be worried about lower prices tomorrow and still confident in higher returns in the future. That should be the default setting right now.

Jonathan Clements reminds us that here’s the least surprising thing you’ll read this week: you can’t control the financial markets. They’re driven by the news — and we simply don’t know what news we’ll get in the weeks and months ahead, whether it’s about the spread of the coronavirus, its impact on the global economy or something else entirely.

But don’t despair. There’s also much that we can control, including how much we save and spend, the amount of investment risk we take, how much we pay in investment costs, our portfolio’s tax efficiency and — most critically at a time like this — our own emotional reaction to market ups and downs.

Recency bias. In 2019, the S&P 500 stocks were up an impressive 28.9%, excluding dividends. This year, they’re down a fairly modest 7.8%. Which number are we focused on? You already know the answer. Instead of celebrating the huge gains enjoyed over the past decade, investors are fretting about the relatively modest losses suffered this year. Our thinking, alas, tends to be heavily influenced by whatever’s happened most recently.

Extrapolation. The S&P 500 has given up 12% over the past six trading days. The temptation is to take the past week’s losses and extrapolate them into the future. But that would be a classic investor mistake: We imagine we can forecast returns simply by looking at past performance.

Unstable risk tolerance. Will those big investment bets involve stashing more in stocks or bailing out? Which way folks jump will likely depend, in part, on how recent market action has affected their tolerance for risk. In theory, we’re supposed to figure out how much risk we can stomach and then build a portfolio that reflects that. In practice, our appetite for risk tends to rise and fall with the financial markets — and right now a lot of investors are likely discovering they aren’t nearly as brave as they imagined.

The illusion of control. Faced with danger, often our instinct is to act. That can make us feel more in control of our destiny — but it may not be good for our financial future. Most of us hold a portfolio built to help us pay for retirement and other goals in the decades ahead.

Clements concludes by asking should we mess with that investment mix simply because of a few rough days in the market? To ask the question is to answer it.