As investors, we must accept that the financial markets can occasionally be a dangerous place. The only certainty we have is that the future will surprise us, as it is unpredictable. If it were predictable, you would not be rewarded for putting your hard-earned savings to use in investment assets.
Willingness to tolerate risk = Opportunity to be rewarded for investment
The current environment we face contains high uncertainty – no one knows for sure how far the coronavirus will spread and how threatening it will be to many human lives, especially the most vulnerable. On top of this uncertainty is unprecedented moves in interest rates paired with the untimely moves in oil prices as a result of an OPEC price war. Most challenging, perhaps, is how to estimate the impact that these variables will have on the global economy. However, we think it is safe to say at this point that most businesses will be lowering their expectations for profits this year, and this is meaningful because the expectations were already high. Perhaps even too high for a non-coronavirus-impacted-world.
Our perception that the “expectations pendulum” had swung too far to the right resulted in us making investment decisions to avoid the most over-promising businesses. The upward move on the stock prices of some of these companies weren’t sustainable. The coronavirus breakout was not expected, but we know that when prices are too high relative to the profits earned, then it won’t take a lot to cause a correction.
In fact, corrections are regularly occurring events for the stock market – remember, we have pointed out in the past that on average a 10% correction happens once a year, a 20% correction happens every 4-5 years, and a 30% correction (or more) happens once a decade. Only after the fact will you know which type of correction it is and what actually caused it. At this point in time, it appears likely that the correction is mostly due to the coronavirus, but again, that’s not the only factor at play.
What matters the most, in our opinion, is that we’ll get through this. Historically, when we suffer a 20% or greater correction, the market essentially breaks even again in about 24 months (on average). Another thing to keep in mind is that the snap back in stock prices can happen very quickly – 24 of the 25 best days in the market occurred within one month of one of the 25 worst days. So, when the drops seem unbearable, remember that the upside can happen just as quickly (a dose of optimism here). This is the reason we don’t want to sell into this fear – in fact, we’d rather be buyers. Selling needs to be done when all the other investors are still very greedy and not in panic mode.
So when the drops seem unbearable, remember that the upside can happen just as quickly. This is the reason we don't want to sell into this fear – in fact, we'd rather be buyers.
Lastly, and we say this constantly, the two most important factors for surviving these storms are: 1) asset allocation; and 2) security selection. We have customized the former to the level of risk you can sustain balanced with the return needed to achieve your stated objectives. And the latter is why we work hard every day to make sure we pick high-quality businesses that have conservative balance sheets (limited risk of having a cash crunch or debt problem) and are durable businesses that can survive the regularly occurring cycles. Between these two things, you have a strategy that will help you ride the rough waters until calmer seas prevail. And they will, but patience is key.
We understand that the anxiety will linger as long as the markets are volatile. Please call us or email anytime – we want to be available to help you through this, as this too, shall pass.
Norris, Perné & French