81 years ago – almost to the day – Metro-Goldwyn-Mayer produced L. Frank Baum’s The Wonderful Wizard of Oz. A tale of a journey fraught with danger and risk in the pursuit of reaching the Emerald City where our heroes discovered their hopes and dreams – along with heart, courage and brains. We are reminded of this magnificent tale when we consider today’s financial markets and its participants.
The last six months have been extraordinary. World economies and financial markets dove into a COVID-19 recession and bear market at warp speed. The US economy contracted a whopping 34% while global stock indexes dropped in excess of 40% and interest rates collapsed – all within weeks. During this time many investors ran scared and aggressively sold everything – with most of those sales close to the March low. The astonishing recovery of stocks since the market’s lowest levels makes this period unlike anything in the history books. Much like the characters who traveled along the yellow brick road, investor psychology during the last six months has been riddled with angst, fear, and more recently, lots of hope and optimism. We believe that some of this optimism may be well placed but also want to remind you that we have a strategy in place should this rosier outlook not come to fruition.
As we consider the recent level of global stock prices we cannot help but have a tinge of distrust, particularly when we consider COVID-19, Recession and Election – Oh My! Does it make sense that stock indexes are back to their pre-COVID-19 levels with the economy in recession and unemployment at historically high levels? Is the market vulnerable at this stage? It is possible that financial markets are “discounting” better days ahead in terms of a virus that becomes manageable or the presence of a vaccine. However, it is also likely that risks not yet apparent are lurking somewhere around the next corner of this yellow brick road. This may include unexpected spikes in the virus, insufficient government stimulus, or an election result that spooks investors.
Our Risk Management Strategy
We, like many investors, feel lucky and grateful that financial markets have rebounded so powerfully. However, we detect a level of investor optimism and in some cases enthusiasm that relies a bit more on “hope” than on research and data. As we like to say in our virtual office meetings, “Hope is not a strategy!” We have a strategy for any unexpected, greater-than-normal decline in stock prices. Our Active Risk Management is the process of being flexible with your exposure to stocks, careful management of the sectors of the economy in which we invest and the use of carefully placed stop loss orders. All of these tools work together to mitigate the risk of catastrophic loss. So, as we continue down the yellow brick road, keep in mind that this strategy is firmly in place.
Better Days Ahead
While we keep an eye on events that could create market downside, we are optimistic that we may be entering a new and very different business cycle. If our world’s citizens can keep their masks on and remain socially distant – until there is a vaccine – we see a not-too-distant future where parts of the global economy begin to grow. In our view the global economy has been re-shaped by this pandemic and like the industrial revolution of the late 18th century, we believe that some industries and business models will be unable to return to their previous glory during this new and different era – while others will thrive. In recent months of stock market strength, we can read what the market is predicting for our future. While many companies have experienced significant profitability and rising stock prices, many more have struggled. This shift should continue to favor our investment style based on selecting individual company stocks as opposed to market indexes. In our opinion, the ability to identify and invest in healthy sectors of the new business cycle and the companies that provide a product or service that is in high demand will result in successful investment results. We are excited about the prospect of a better managed pandemic, a future vaccine, and the opportunity to invest in the companies that will be leaders in the new business cycle and bull market. The great city of Oz may be in sight.
Many professional and individual investors are concerned that the upcoming election will create significant market downside. In our view these fears are misplaced. For one, there is a large “crowd” of investors that think this way and the “crowd” is usually wrong when it comes to investing. More importantly, much of the pessimism about the election in terms of the stock market centers around Joe Biden winning. We often hear two forms of speculation in this regard. The first is that Republicans have a better stock market track record than Democrats – this is just not true. Policy, rather than politicians, influences economic growth and sectors of the economy. Secondly, there is a misplaced fear that a Biden administration will raise taxes and repeal growth policies in the near term. We find this hard to believe given the fragility of today’s economy. In our view, the Biden administration’s “hands will be tied” in terms of meddling with taxes or growth policy until the economy is on very strong footing – think 2022. Though much is being debated regarding the election and its effect on stock prices, we think investors would be better served by focusing on the economic recovery and growth in terms of the future of stock prices.
During the market’s significant recovery over the past few months we have experienced very few normal market corrections, which usually range from 8-12%. We are likely in the midst of one now which frankly is overdue and heathy for higher highs. Should the stock market show signs of a normal correction – perhaps based on COVID-19 or the election – keep in mind the difference between normal volatility and something worse.
We certainly live in interesting and profound times. The pandemic, economic instability and market volatility remind us of the value and importance of having the heart, courage, and brains that were so desired by the characters from L. Frank Baum’s spectacular tale.
All of us on the team thank you for your continued vote of confidence during this extraordinary year and we are grateful for the opportunity to be the stewards of your wealth. If you have experienced any significant changes in your financial position or have any questions about our work, please feel free to contact us.
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