This article was first published in the National Post on March 14, 2020. It is being republished with permission.
by Tom Bradley
You’re watching stock markets gyrate wildly. The ramifications of the coronavirus are getting scarier every day. Meanwhile, you’ve done pretty well with your investments over the last decade. So, what should you do?
A common refrain is, “I’m going to move my RRSP into a money market fund and wait for things to settle down.”
This is totally understandable. It’s the easiest, most comforting action you can take, but there are some things to consider if you’re going down this path.
The second decision
After you’ve shifted and finally had a good night sleep, you’ll wake up to the most difficult decision in investing — how to get back in.
It’s hard to time the market at the best of times and almost impossible when you’re sitting in cash. I say that because you’ve made a huge bet and the stakes are high. Your portfolio is nowhere near the target asset mix in your plan.
You may have been decisive in selling, but you shouldn’t expect the same clarity when the time comes to reverse the trade. The late Peter Bernstein put it this way: “In calmer moments, investors recognize their inability to know what the future holds. In moments of extreme panic or enthusiasm, however, they become remarkably bold in their predictions: they act as though uncertainty has vanished and the outcome is beyond doubt.”
The second decision is also difficult because Mr. Market interprets news differently than we do in our daily lives. He’s not looking for good news like we are. ‘Less bad’ is all he needs to spur a turnaround. In other words, the market will have recovered a good portion of its losses by the time the headlines turn more positive and you’re more comfortable.
Expected returns diverging
Your situation is unique and there may be many reasons to de-risk your portfolio. Looking in the rear-view mirror at what just happened, however, should not be one of them. Investing is forward looking and what we’re seeing through the windshield now is a total reset. We’re operating on a new set of assumptions.
The economy is going to be weaker (for an unknown period) and there’s a good chance of recession. Heavily indebted families and companies will be tested. And the coronavirus will lead to big winners and losers.
There’s also been a significant divergence of return expectations. With the rapid decline of interest rates, safety is now more expensive than ever. Government bonds and GICs are yielding almost nothing.
Conversely, expected returns for risk assets are higher. The yield on riskier bonds (issued by less creditworthy companies) has risen. The extra yield above government bonds, or spread, implies that more companies will default on their obligations, but overall, the outlook for corporates has improved.
Outlook worse, potential better
The outlook for stocks is considerably better. Price-to-earning ratios are lower (based on normalized earnings), and dividend yields higher. Profits, or losses, in the coming quarters will be disappointing, maybe even disastrous, but in most cases, share prices have dropped more than any damage to companies’ long-term value. Indeed, the well-positioned players may be able to enhance their standing over the next year.
Every meltdown has a different underpinning, but over history there’s been a consistent theme. Stocks overreact to economic and market shocks, which sows the seeds for dramatic recoveries. After a tough fourth quarter in 2018, markets were back to their highs by Easter. In 2011, there was a 20% market decline between April and September, but again, the indices had fully recovered by early 2012. And six months after the start of the great financial crisis of 2008, the stock market was back on a rocket ride. Markets act first and sort out the details later.
Eyes wide open
If you’re considering selling your stocks, or have already done so, I’d encourage you to make it a temporary move. You’re paying a hefty price for safety at a time when the reward for taking risk has improved.
The current crisis is like no other we’ve seen and is hitting close to home. But people will continue to need products and services, and stock prices are now at a level where you need to start focusing on the ensuing recovery. Markets may go lower, but your long-term success is more dependent on being positioned for the up than avoiding the last stages of the down.
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