Three important ways to think about investing in the current markets

  1. Portfolio falls are temporary moves that become permanent losses only when investments are sold
  2. Market volatility can be an investment opportunity for the longer-term.
  3. Investment success shouldn’t be measured against beating short-term returns – it’s about being on track with the right strategies to achieve your important financial and lifestyle goals

COVID-19 has brought massive short-term changes to our world, economy, and markets. Looking back on the first quarter of 2020, there’s a dizzying amount of data and information to digest and understand. So, here are a few important but simple points to keep in mind about investment markets, despite the unusual times we’re in.

Selling Locks in Losses

Falls in investment values don’t become losses unless they are sold when markets are down. Faced with this information, you might expect all investors to simply stay invested through market uncertainty. However, this is often not the case, even when investors know what’s right. People’s emotions can get the better of them, leading to decisions that can erode the value of their portfolios and make it hard to stay focused on the important financial and investment strategies that will maximise their financial outcomes.

Conversely, investors that stick to their strategy (that is, re-balancing or behaving counter-cyclically after a market decline) tend to produce better results over the long term than medium-term trend followers. That is, those that sell after falls and buy after rallies.

Selling after a market decline, locks in not just one loss, but likely two. Historically, markets have typically rebounded after a large decline. If you get out of the market, it’s very likely that you’ll miss the rebound. Missing the rebound is not just a lost opportunity, it statistically sets you up for lower long-term returns than if you hadn’t done anything.

Exhibit 1 illustrates this point. It shows $1 invested in the equity markets, represented by the MSCI USA Index, at the beginning of the year 2000. Three scenarios emerge from the global financial crisis in 2008-2009:

  1. One investor holds on after the fall
  2. One sells and waits a year before buying back in, and
  3. One gets out and stays in cash

The decision makes a significant impact on portfolio returns, with the one staying put ending with $312, nearly 50% more than the one who spent a year in cash, and almost 5 times the value of the one who got out of stocks and stayed out.

Exhibit 1. The importance of staying invested - Graph

Market declines, even double digit ones are to be expected from time to time. In fact, the willingness to see portfolio values move around is one reason our clients are rewarded for investing over the long term. We think staying focused on the long term can help people make better short-term decisions.

Taking Advantage of a Market Decline

For investors that think about markets in a long-term way, market volatility presents an investment opportunity not a risk. Imagine that you own a farm, and every day your next door neighbour offers to either buy your farm or sell you his farm. Some days, when crop prices are high, he may offer you way more for your farm than it’s probably worth, and when crop prices fall, he offers you his farm for peanuts.

When prices are low and people are selling, should that make you want to sell? Should your neighbour’s depressed mood lead you to sell? Because that seems to us to be the best time to buy. A better time to sell would be when your neighbour is very optimistic and you can get a much higher price for your farm.

We think it’s the same with investment markets, they are there to serve us, to allow us to buy when prices are low and to sell when prices are high. Don’t follow the herd, they’re not looking out for you.

Again, looking at past market declines can give us a better idea about what typically happens in these environments. Exhibit 2 shows that the three and five year returns after a decline are significantly positive. Only the dot-com bubble burst was not followed by a considerable increase, largely because the global financial crisis intervened. For most, however, crises represented opportunities to invest.

Exhibit 2. Market recoveries after bear markets - Graph

Am I on Track?

Investments are one of the six areas of financial advice that require strategies as part of an ongoing plan to achieve the financial goals that are important to you in life …click here to see Fintech’s full spectrum approach. For most individuals, important underlying questions are often centred around “will I have enough money” and “am I on track?” Well designed financial strategies do not rely solely on investment returns. But we know that many people substitute an evaluation of their investment performance in the short-term for a sense of their progress toward their goals in life. Evaluating the portfolio tends to lead to simplistically comparing portfolio performance to benchmarks or peer groups. This is an incomplete way to the assess investment strategies, but more importantly it can focus investor attention on the short term. This can unwittingly lead to wealth destruction if the investor lets fear or greed override their emotions and decision making – switching from one strategy to the next (again, see Exhibit 1).

We think a better question to ask is whether the financial strategies that make up your plan are still appropriate and will maximising your overall progress towards your goals. Bringing the conversation back to the purpose of the plan and the time frames involved, can help shift the conversation from short-term performance to achieving the things that are most important to you over the long-term. This also allows for the power of compounding returns to weave it’s magic, or as Einstein famously put it “the eighth wonder of the world”.

Plans that are built for volatility and with redundancy, recognise that investment returns can be uncertain when viewed with a short-term focus. However, by having your investment structures professionally designed and implemented as part of your overall financial strategies, you are able to overcome uncertainty and stick to your plan. Despite short-term declines, your long term goals are able to remain on track with the right financial advice and strategies in place.

Exhibit 3. Shifting focus from markets to long term goals - Graph

It is especially important in times of disruption and uncertainty to focus on these three points, and take advantages of the opportunities that arise through periods of market volatility!

Please stay safe and well while the Coronavirus runs its course.

Firstly, we wish for you and your families to remain safe and healthy as the Covid-19 (Coronavirus) runs it course. What began in December 2019 with a handful of mysterious illnesses in the central Chinese mega-city of Wuhan has travelled to other parts of the world, jumping from animals to humans and infecting close to 90,000 people to date. It has triggered unprecedented quarantines in China and a string of countries have now closed borders with Italy and Iran (including Australia) given the spread of the virus there. South Korea has delayed the start of its school year amid a spike in cases, and there is a possibility that the Olympics in Japan will not proceed as planned. This is effecting global supply chains and is causing fear in investment markets in the short term.

Most cases of the virus are mild, but health officials say its spread around the globe may be inevitable. From a non-financial point of view, it appears that frequent and proper washing our hands with soap is one of the simple things we can all do to reduce the chances of contracting or communicating the illness.

In addition to the life threatening public health crisis, Coronavirus is also posing an economic and market threat. Globally and in Australia, we have experienced a sell-off in investment markets in excess of 10% (technically known as a ‘correction’) as investors react to the growing numbers of Coronavirus outbreaks.

First quarter GDP could be negative, both in Australia and globally

March 2020 quarter Gross Domestic Product (GDP) growth is likely to be negative, possibly leading to a stalling or even decline in the global economy. However, it should prove short lived.

With many Chinese staying at home as confirmed by various indicators around transport congestion, coal consumption and property sales, the hit to Chinese growth and the flow on to the global growth will be big this quarter. It’s possible that global growth will be zero in the March quarter or may even contract. Rough estimates suggest that 30% of China’s population and 50% of its GDP is under lock-down and each week this remains the case will knock 1% off Chinese annual GDP and nearly 0.2% directly off global GDP. However, if the outbreak is contained in the next month or so as we expect then growth will bounce back in the June quarter and share markets will largely look through it, albeit with the high risk of further short term volatility.

For Australia, we see the combination of the drag from the bushfires and coronavirus detracting around 0.6% from 2020 March quarter GDP which will see the economy go backwards by around -0.1%. However, growth is expected to rebound in the June quarter as the rebuilding from the bushfires kicks in and if as we expect the Covid-19 outbreak is soon contained. There is a lot of uncertainty around all of this though and its come at a time that the economy was already weak with high levels of spare capacity leaving the Reserve bank of Australia (RBA) a long way from meeting its growth and inflation objectives, so we continue to see further interest rate cuts (monetary easing) from the RBA in the months ahead and a stepped up fiscal stimulus (tax cuts) in the 2020 May budget.

Please rest assured that Fintech Financial Services is reviewing the situation closely with our specialist investment managers to ensure your long term portfolio objectives are maintained. Times of concern and crisis requires rational thinking and a disciplined approach to stay on track – not only to address any short term impacts – but to take advantage of the long term opportunities that unfold as investment markets react with fear and panic. We will keep you up to date as the situation evolves. For now, stay calm and don’t let the barrage of news and media updates about the Coronavirus cause you too much concern.

The sensible long term view

In six months’ time, we believe that we will be looking back at the coronavirus, mourning its victims and at the same time marvelling at the resilience of markets. History may be no judge of future performance but in this case it is a reminder of how past outbreaks have left a shallow impression on markets.

From the Severe Acute Respiratory Syndrome (SARS) outbreak in 2003 to the twin strikes of Ebola in 2014 and 2016, and a bout of Zika in between, disease has made headlines and jostled markets. However, each time the outbreaks and the financial losses were eventually contained. “Market participants tend to react to such unforeseen outbreaks,” says Morningstar Investment Management’s Carolyn Szaflik, “but markets tend to recover by the six-month mark. This suggests that sentiment drives early losses, but sustained economic impacts are likely to be less than investors fear at the onset.”

How markets have reacted to previous outbreaks

From SARS to Ebola: market immunity

Since 1998 there have been nine global epidemics but little evidence linking them to long-term fundamentals. For investors, that means avoiding the hysteria and focusing on the factors that make businesses worth investing in.

Exhibit 1: Investors tend to react to epidemics, but the long-term picture is positive

 

A key consideration for the moment is the potential effect of coronavirus on the cash flows of affected businesses. Empty streets in China, fewer flights, fewer customers, less turnover, and crucially, a hit to global supply chains will cause a drop in the output for the world’s largest economy (China). The damage will emerge in future earnings reports.

Exhibit 2: Market reaction to global epidemics

That said, “it’s not necessarily a trigger to dump stocks, crystallise losses and seek refuge in cash,” says Szaflik. Share prices may have dropped but China is on the case. Its stimulus measures have curbed the losses and the country’s central bank is set to lower the lending rate and relax rules around how much money banks have to keep in reserve.

So what to do?

Economist John Maynard Keynes said it best in the following quote “When the facts change, I change my mind. What do you do, sir?” It’s a bit like that now. Watch and wait. If we were to see a clear and significant potential impact to investment fundamentals, we will carefully study the situation, conduct rigorous scenario analysis, and incorporate the new information into our portfolios. We certainly won’t be hitting the panic button and recommend that you don’t either.

 

In summary

In summary, a cautious approach is warranted in the near term until greater confidence is reached that the number of new cases of Coronavirus has peaked, seeing economic activity rebounding again. Fintech Financial Services is committed to utilising the market leading research providers and investment managers in the market to not only mitigate risk in your portfolios, but look for opportunities to position for the eventual rebound in hard hit emerging markets and Chinese shares, commodities, resources and travel stocks. Buying opportunities are also presenting themselves in the more resilient US, European and Australian share markets.

Stay calm and we will keep you up to date with how things are progressing.

Grant

The Reserve Bank of Australia (RBA) has left the official interest rates on hold at it’s first meeting for 2020 today.Reserve Bank of Australia

The cash rate decision comes at a time when the bushfire emergency and coronavirus outbreak weighs heavily on the Australian economy.

Improved employment data likely buoying the reserve bank’s outlook, even though economic growth has remained subdued.

This means the cash rate remains at 0.75% for the time being. As we have previously outlined, the cash rate is likely to remain “lower for longer” as inflation around the world has remained at stubbornly low levels.

Fintech Financial Services believes that it is unlikely that this will be the end of the RBA’s successive cuts (0.25% cut in the months of June, July and October 2019). Prior to October last year the RBA held the official cash rate at 1.50% for 30 consecutive months. The recent natural disasters, including droughts, floods and bushfires and the economic ramifications of the coronavirus outbreak make another cut in the near future likely.

With the economy a long way from the RBA’s full employment and inflation objectives, the bushfires likely to slow growth in the short term and the China coronavirus posing a new threat to global growth and tourist arrivals, the RBA had many reasons to cut rates at today’s meeting.

Going forward, the RBA is also likely to be considering the impact that another cut could have on consumer confidence, which has been down; given that the general public can perceive this as a message that the economy is going badly and we are in for tough times ahead. However, this is more due to the bank’s inability to communicate its intent.

Deloitte signageDeloitte Access Economics reported in their Business Outlook in January that there’s a large gap between what the RBA is saying, and what families and businesses are hearing. The RBA is boosting the economy both because it is weaker and because it is different. The first factor on its own is a concern for families and businesses, but the second, a different economy with more profits and more jobs – but less in terms of wages growth – is actually a mixed blessing.

If the next rate cut occurs as expected, it will bring the official rate cash rate to 0.50%, just a single cut from the point where RBA Governor Philip Lowe has said he would consider instituting a Quantitative Easing program (printing money). With the Australian economy now beset on all sides, it seems likely that there will be another cut soon.

This means that those holding Cash at bank or in Term Deposits to generate income, are going to find it even harder to maintain their income needs and lifestyles as a consequence.

This also means that investors will continue to look for ways to earn higher levels of income from other sources like dividends from Shares, rents from Property & Infrastructure and returns from higher risk Mortgages and Debt Instruments like unsecured Corporate Bonds. These assets class types have been pushed higher over the past 2 to 3 years as sustained low interest rates have created a ‘yield chase’ scenario. Some of these investment types are looking fully value or sitting above fair value as a result.

Therefore, it is very important for your portfolios, not only to be in line with your ‘Investment Risk Profile‘ and the reasons / objectives why you are investing, but to be made up of individual investments that represent ‘fair valuation’ or better, and utilise the leading investment research houses to deliver this to clients.

Please contact us if you would like to discuss this in relation to your specific circumstances.
Grant