Markets Still Trying to Thaw

Join CIO Chris Perras for the 4/02/2020 edition of Stock Talk: Keeping you Connected to your Money!

Chris Perras: Good morning. I’m Chris Perras, chief investment officer at Oak Harvest Financial Group in Houston, Texas. Welcome to our weekly Stock Talk podcast: Keeping You Connected to Your Money. Outside of the Russia-Saudi Arabia oil skirmish, news surrounding the coronavirus has been the driver of all financial markets since late February. The duration and volume of COVID-19 virus-related news and its lingering effect on the economy can’t yet be determined.

We continue to counsel our clients and prospects to control what they can control. Investors should be mindful of their perspective matters. In investing, time horizon always matters. The longer the holding period, the lower in assets volatility, and the higher one’s expected returns. After failing early in the week last week at 2,630 on the S&P 500, which is the 200-week moving average, the market now sits around 2,530 as of the opening this morning. The futures this morning were pointing 1% lower.

The economic fallout of shutting down the economy, which is over 70% service-based here in the United States, in order to slow the virus has begun to show in the economic numbers as unemployment claims have spiked historically high and historically fast. That being said, the markets will begin recovering before the economic news improves, just as the markets peaked and rolled over while the data was still outstanding in late February, only five short weeks ago.

News on the productivity of diagnostic testing and improvements in lowering the virus spread curve through social distancing will likely lead financial markets’ recovery. The good news on that front is China and Korea are improving and slowly getting back to work. In Europe, it looks like the virus spread in Italy and Spain looks to be peaking and slowing. However, domestically, it looks like things are still in the acceleration phase. On the good news domestically, Governor Cuomo in New York did bring a bit of optimism this past Wednesday to that state as he now believes that the spread curve there might peak as early as mid-next week instead of later in the month of April.

Social distancing does work and is working. However, the US has left states responsible for their own social distancing policies, and there will be more outbreaks throughout the States. The early thawing signs in the financial markets that we spoke of on our Tuesday, March 24th podcast that started late the week of March 18th continue to try to emerge slowly. Treasury collateral volatility is now back to around six, which is where it was early March, around March 4th.

Now, readers, this is still two times the normal level, it’s normally around three. To put that in perspective, stock market volatility would need to fall about 50% from today’s level to reach that type of level. That would put the VIX index, which is often quoted on TV, between 25 and 30, which were high and is double its normal level in a calm environment of 12 to 15. Falling to around 25 to 30 would be very positive for equities rebounding sooner and higher than most people expect.

Valuations have dropped significantly in the last five weeks. The S&P 500 had been trading at almost 20 times trailing earnings in mid-February because the economy was accelerating. A forward earnings guidance is almost impossible to predict now. The market has quickly adjusted its valuation down to, this week, around 15 times trailing earnings, which has been a pretty good area to invest over the past 30 years.

In less than five weeks, the financial markets have priced in an economic recession. The question that remains is how long and how deep the economic downturn will be. Given the historic uniqueness of this event, it is impossible to predict with any accuracy those two variables. However, long-term investors know that dollars they invest during economic downturns, while uncomfortable, have been their highest compounding return assets over the subsequent longer-term holding periods measured in years.

Buying assets while others are forced to sell or are just emotionally panicked has been the way to compound your returns at higher rates over time. Buying strong balance sheet, high quality, dividend-paying, and dividend-growing stocks and reinvesting those dividends over time and more shares of these companies has been a proven long-term strategy for building wealth in stock markets. Trying to predict the final timing of events like what has transpired in the last five weeks is impossible. Trying to time the bottom and buy the lows is impossible. Clients may log into our web portal and reference the next few slides we have from you from BlackRock.

The first slide, by the way, BlackRock shows how little an investor misses out on by market timing and buying the exact lows in a bear market. They studied the last 13 bear markets over the last 70 years. The average annual one-year return for stocks the last 70 years is 9%. That’s the key number to look at and to remember for anyone doing financial planning, anyone investing in the market, not short-term trading. 9% per year. Unfortunately for us, this 9% is not linear each and every year.

Look at the chart provided by BlackRock. If you were perfect, which no one is or ever will be, in buying every bear market low during the last 13 episodes, you would have returned about 35% in the next 12 months. That’s a huge number, and the greedy part of every investor longs for that number. However, if you were two weeks early buying stocks from the bottom, you returned 24% over the next 12 months. That’s still a big number. If you were two weeks late, you returned about 21% the next year, another big number for a one-year holding period return.

Regardless of your timing, although perfect, whether you’re early, whether you were late, your incremental investments during bear markets returned two and a half to four times the average annual stock market return over the next year. I repeat, that’s over the next year. Remember though, stocks are supposed to be long-term investment vehicles. The whole notion of a P/E ratio is what you’re paying for one year’s earnings.

A single year or two is not long-term in the stock market. Listeners, if you buy stocks near the bottom of a bear market, within a few weeks or a few months of the lows, what happens to your overall expected returns over the next 10 years? Your average annual return goes up from about 9% to around 10% to 11% per year. What does this mean to you? Almost everyone’s emotional instinct is to sell stocks or raise cash in bigger stock market downturns. The correct long-term investment strategy is to put incremental cash to work. At worst, the right strategy is to sit tight in your allocation that was laid out during calmer times in your financial plan with your investment advisor.

Most of us have heard the statistics behind market timing, how poorly traders and investors fare if they try to market time, how it’s time in the market, not market timing that leads to higher historic compound annual returns inequities, how if you had missed the top 25 returning days in the market over the last seven years plus, your total return in stocks would have been close to the same return as a cash account.

Case in point, over the last 20 years, 24 out of 25 of the worst days in the stock market are within the same month as the 25 best days. BlackRock has provided a great slide that outlines more on this topic. They take the 15 worst days, trading-wise, they take the 15 worst months in 15 worst three-month periods in the stock market in the last 70 years, and they look at the subsequent average returns over the next year. While they are just averages, the average return in the next year following each one of these worst time periods was between 20.5% and almost 24%. Those are great returns for just staying put.

The markets and economy are being hit with a historic event. However, our Federal Reserve, through its monetary policy, elected political officials through unprecedented fiscal action. The scientific community through global coordination and our shared public sacrifice through social distancing have taken and are taking historic steps to combat this virus. Your highest compounding returns come from buying equities during economic downturns regardless of their cause. One of the worst things you can do is sell your positions and go to cash during times like this. The Black Rock charts make that point to our viewers.

History has proven over and over again that long-term investors with patience and the ability to tune out the noise make the most money and have the greatest security. At Oak Harvest, we are comprehensive long-term financial planners. What this means is that as our client, you and your financial advisor should have a financial plan that is independent of the volatility of stock markets.

Anxiety and risk aversion is likely to continue into the second quarter ahead as our country implements measures to fight the spread of the virus here in the States, which undoubtedly will continue to cause negative growth. If you are retired or in the process of retiring, please give us a call at Oak Harvest at 281-822-1350. We are here to help you plan your financial future, to help smooth the financial path you have into and through your retirement years with a customized retirement planning. Many blessings. This is Chris Perras with Oak Harvest Financial Group.

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