March 20, 2020
In times of great uncertainty, it is most important to stay focused on what is truly important. As society works through what has become a full-blown global pandemic, we want to first extend our best wishes to all your friends and family. Please be safe, stay vigilant and remember we are all in this together.
“The only thing we have to fear is fear itself” -Franklin D. Roosevelt
Financial markets have experienced tremendous volatility of late and fear is a natural human reaction. Our job is to stay emotionally grounded and firmly rooted in a long-term process. Leading up to March, we were told by some people that our portfolios were too defensive as many scrambled to take on more risk. Our process identified that trouble was brewing so we encouraged some clients to move their accounts to other firms rather than adding more risk than we were comfortable with. As clients/readers know, the investment portfolios we oversee were shifted relatively defensive prior to the collapse in global stocks & we have actively managed risk during the decline.
We have navigated this historic event in the following ways:
- Back in January our data-driven process identified the possibility for significant fragility in various markets. Simply put…speculative positioning had become notably crowded and bordered on euphoric. (As we pointed out in notes to clients on several occasions.) This signal was made stronger by the fact that corporate earnings growth had been slowing amidst a weakening economic backdrop. To use a metaphor…we look to identify the possibility of an avalanche and not to forecast the exact snowflake that triggers it. Ultimately the Covid-19 virus was the catalyst that sent markets into a free-fall and we had higher than normal cash levels.
- In early March, we quickly exited all investments connected to Energy. This decision was made based on a change in facts surrounding the analysis of supply and demand in the oil market. Saudi Arabia and Russia entered a price war for market share and started flooding the globe with oil at the same time demand was seen collapsing due to the coronavirus spreading. The price of oil is down roughly 30% and many related investments much more since we exited all associated positions earlier in the month. Risk/reward dynamics changed and we acted.
- Credit markets have been a concern going back many months and we reduced exposure across portfolios prior to and in the early stages of what has become a collapse in various types of bonds. This allowed us to maintain true portfolio diversification as corporate bonds have declined sharply alongside stocks. We firmly believe that risk management should always extend beyond stocks.
Where do we go from here?
We believe active risk management has allowed our portfolios the opportunity to confront the current situation from a position of strength. Having played defense going into and during what has been a historic sell-off allows us to become offensive by investing in things that have collapsed. We firmly believe that now is the time to look for value.
Although no one can predict exactly how things will play out in the near term, here is what we do know:
- A large portion of the recent selling across markets has not been fundamentally driven but instead the result of institutional investors being forced to cut positions in a low liquidity market. Big firms invest with leverage (borrowed $) and when volatility picks up, many are forced to sell all positions regardless of fair value. This has recently occurred on a large scale in a market that is far less liquid than during past times due to post financial crisis regulations limiting the ability of banks to participate in ensuring smooth market functionality. Ultimately volatility spiked, big firms were forced to sell, and there haven’t been enough market participants willing to buy. This has created a snowball effect where rising volatility and indiscriminate selling becomes self-fulfilling. In addition, we believe large sovereign wealth funds from oil rich nations have reacted to the crash in the price of oil by selling down holdings of various securities to raise cash. In our opinion, all of this could be making assets far cheaper than the underlying long-term fundamentals suggest.
- Unlike the global financial crisis of 2008, the current situation is the result of a massive shut down in the real economy and not a financial panic. This shutdown is self-inflicted as governments are correctly opting to protect the lives of citizens at the expense of near-term economic activity. Once the health crisis moves beyond the acute phase, we believe there will be unbelievable pent up demand from consumers all over the world. In our opinion, cheap oil adds greatly to this going forward.
- The U.S. Federal Reserve and various other central banks have rushed to stimulate by cutting interest rates and directly pumping hundreds of billions of dollars into the financial system. Worldwide fiscal stimulus to the extent never before seen is coming and will likely prompt an eventual increase in household spending as people across the world will inevitably carry on with their normal lives. Interest rates are at all-time lows and this should nudge people to do all sorts of things from shopping, investing in businesses, and refinancing or buying a new home. We like to think we are in front of this…with A LOT of dry powder in client portfolios.
As always, we would like to remind each of you that we do not take for granted what we get to do for all our clients. We are here, at your service, for any of your financial needs, concerns, or questions. We are truly grateful for what we get to do for each and every one of you.
‘Be fearful when others are greedy and greedy when others are fearful’
-Warren Buffet
Ryan A. Mumy, CFP®, AIF®
Chief Investment Officer
rmumy@capital-invest.com
Disclosures: The information provided in this paper is for general informational purposes only and should not be considered an individualized recommendation of any particular security, strategy or investment product, and should not be construed as investment, legal or tax advice. Capital Investment Advisory Services, LLC makes no warranties with regard to the information or results obtained by third parties and its use and disclaim any liability arising out of or reliance on the information. This information is subject to change and, although based on information that Capital Investment Advisory Services, LLC considers reliable, it is not guaranteed as to accuracy or completeness. Source information is obtained from independent financial data suppliers. For investment related terms definitions, please visit: www.investopedia.com Past performance is no guarantee of future results. Advisory services through Capital Investment Advisory Services, LLC. Additional information about CIAS and its From ADV Part 2A are available on the SEC’s website at www.adviserinfo.sec.gov