Managing Portfolios Through the ‘Great COVID Crisis’


David Sowerby, CFA, Managing Director, Portfolio Manager

Three months have passed since the stock market peaked on February 19th. We can only attempt to describe what the past three months have been like with natural concern for family and friends, insatiable amounts of reading and listening to conference calls and podcasts, thoughtful discussions with peers to discuss views and, most importantly, pride in family and colleagues who, as expected, have risen to meet this challenge.

There are several items worth pointing out about the current market. The first is market breadth. The S&P 500 is off roughly 15% from its February 19th peak, which, to borrow from the legendary broadcaster Paul Harvey, does not tell “the rest of the story.” While the index has declined about 15%, the median company in the S&P 500 has fallen by 20%. As of early May, approximately one quarter of the market capital weighted S&P 500 return had been generated by five stocks. In other words, one percent of the 500 companies in the index had delivered one quarter of the index’s return. There are both good, and not so good, elements to that fact. The not so good is that the decline has been more pronounced than simply looking at the index headlines. The good, is that the breadth of potential opportunities is compelling for active managers.

The second item worth considering is reflection. Anytime you go through a stressful period in the market, it is good to reflect. This is now my ninth bear market working in the investment profession. Throughout the past three months, I’ve realized that some of my favorite time-tested rules have proven to be as relevant now as they were before the virus dominated our daily lives. Here are some that resonated once again with me during this period.

  • As an investor, recognize what you know and, more importantly, what you do not know. This especially includes the unpredictable nature of economic forecasts during the economic shutdown.
  • The effort to draw parallels to past bear markets, including the World Trade Center attacks, the Great Financial Crisis and the 1918 Influenza Pandemic, are just as likely to be unhelpful as they are to hold any accurate insights as we look at our current crisis.
  • Investment decisions need to be based more on what a company is likely to look like in 3-5 years, especially when near-term price volatility can overwhelm one’s analysis.
  • Periods of uncertainty make investment decisions more uncomfortable. This is especially true when you take a non-consensus view. However, you tend to produce better long-term returns when you run against the herd.

The third topic is admitting that as a long-term investor there are going to be times where there are questions without immediate answers. Among the more frequently discussed current issues is the significant amount of stimulus, both monetary and fiscal, which has now totaled $9 trillion, or 38% of U.S. GDP. To be fair, this stimulus is less robust than a long-term tax reduction. Nevertheless, when combined with the Federal Reserve’s expansion of its balance sheet, the sheer size of the stimulus is significant. The stimulus is measured against an assessment of how the consumer will reenter the economy and the length of time labor markets take to recover. To be concise, this is what weighs most heavily on the stock market. There are simply too many unknowns to have a firm opinion. Candidly, those who believe they do know what’s to come may unfortunately fall into the category of “those who don’t know what they don’t know.” We are taught to invest in the ability of the U.S. economy to prevail over the long term, yet we recognize the unique nature of this crisis and its potential impact on consumer behavior. As a personal example, when do I choose to get on a plane, stay at a hotel or attend a research conference? While this crisis has its unique features, and short-term forecasts are extremely uncertain, investment opportunities do exist. The median large, mid and small cap stock (S&P 1500), remains 24% below its February 19th level. Wall Street has attempted to draw parallels between this crisis and past ones to extrapolate what the future may look like. While tempting, it is probably more prudent to acknowledge that each crisis and bear market have their own unique DNA.

In closing, the final item I’d like to discuss is resiliency. Time and again it has been wise to believe in the ability of the U.S. economy to pick itself up and return to growth. One of the market’s greatest virtues is its ability to reward investors for their patience and resiliency. Consider the investor who had the unfortunate timing of buying into the market right before the three most recent (pre-COVID-19) crises. Specifically, buying just before the peak of the 1987 crash, the 9/11 terrorist attacks and the September 2008 Lehman bankruptcy filing. Despite what would appear to be poor timing, their investments, if held for five years, would have yielded favorable returns. Each crisis had its own unique features, but what was common was the ability of the U.S. economy, its companies and citizens to prevail in a system of free markets and capitalism. Choosing a five-year time period to measure returns would seem appropriate as being neither too short, nor too long. Returns also exceeded buying a 5-year U.S. treasury as a substitute. The table below provides the specifics.

5-Year Returns: S&P 500 Index Purchased Just Prior to Market Decline

Purchases Pre-Decline
Source: Bloomberg

The market sell-off during this COVID-19 crisis is in the category of “the risk you did not know,” as something that was simply not identifiable in advance. As such, it reinforces once again, that good, long-term investment planning involves focusing on how you are positioned, and what you own, before a potential decline.

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