April 7, 2020 – Mind the ShepherdSubmitted by Alsworth Capital Management, LLC on April 29th, 2020
In my last letter I advised you not to kill the sheep, but instead to keep it fed and alive, so that we can shear the profits in a recovery. While I have been exceptionally busy on the phone and through emails, talking through portfolio strategy, I have not had one client (yet) instruct me to kill the sheep and sell out of stocks. This fact gives me great joy! Part of my job is to make sure that you have a portfolio asset allocation plan for all markets, good and bad. That means having enough growth that you might be frustrated with lagging the stock market during bull markets, but that you stick to the plan. It also means having enough downside protection, so that you aren’t driven to kill the sheep, despite your inevitable discomfort in a bear market. So far, so good. Tolerance for downside is really only tested in the down markets, though. We do our best, utilizing psychology tools like FinaMetrica questionnaires and working through financial planning scenarios to better understand what makes you tick. If you are at your boiling point, please reach out. It’s better to talk it through than to cause yourself emotional harm. Despite my best advice to not kill the sheep, it’s more important that the shepherd lives through it. You have to be able to sleep and manage your heart rate.
Despite training myself for two decades to be as unemotional as possible, I also have sleepless nights. I am responsible for the financial well-being of all my clients and the many people and organizations that rely on each client. It’s a heavy task. I have spent a fair amount of time in the wee hours of the night, reading up on every comment and analysis offered by my trusted sources. This includes our consultants Litman Gregory Research, research sources like Morningstar and Ned Davis Research and the many portfolio managers and market strategists I trust. I try to stay true to the data and be as reasoned and unemotional as possible when making decisions. Digging into the data helps put rails or boundaries on our assessment of the current state of the world.
In our optimistic scenario, we can imagine that a treatment to lessen the severity of the symptoms for COVID19 is developed quickly, keeping the death rate low and buying time for the ultimate vaccine soon. With lessened risk, we might release from our shelter-in-place sooner and get back to economic activity by the end of the month. There would inevitably still be a second wave of contagion, but with better treatments, we could handle the symptoms and build up our own immunity. As the virus spreads, more of the population would get sick, treat the symptoms, build immunity and get back to normal without much risk of getting it again. Much like the chicken pox. We could build up “herd immunity” in large numbers, still act cautiously with the most vulnerable of age and health, then develop a vaccine to allow the most vulnerable to enter society again with less risk. It seems like a reasonable, though optimistic scenario. In this case, the economy could get back to a decent run rate and as people gained confidence, they would get back to normal interactions and the economy would recover. The stock market should recover in anticipation.
The pessimistic scenario is that a useful treatment is not developed, and we must maintain a shelter-in-place stance for many months to keep the rate of infection low enough for our hospitals to handle the patient load. We would also need to slow the spread to ration masks and ventilators. This would extend the period of economic stand still and require substantially more fiscal and monetary aid to keep the economy artificially propped up. The impact to society from a psychological standpoint could be quite damaging and could cause people to withhold economic activity (discretionary spending, house projects, car purchases) for an extended period of time during the shelter-in-place order and beyond. This scenario would result in a long, extended recession that could take years to recover from. We would still expect an eventual vaccine under this scenario, but the recovery period would be extended as a result of the long period until the virus risk is contained.
We can’t predict the future. We don’t know if we will end up with the optimistic Bullish scenario or the pessimistic Bearish scenario or something in between. However, it is important to recognize that in either scenario, the world does eventually get back to normal interactions. The virus will not live on forever without a vaccine or treatment for symptoms. I’m confident in that. In either scenario, I’I believe that our elected officials will develop additional stimulus measures, if needed, to keep the economy artificially churning. There will be long term consequences, but keeping the wheels moving is of most importance near term. In either scenario, I’m confident that we will eventually see new highs in the stock market. The question, in my mind, is just how long do we have to wait and how deep will the recession be in the meantime.
My base case scenario at this moment in time is that the shelter-in-place order is likely to continue in one form or another, in this country, until at least the end of May. Perhaps New York, California and Louisiana will peak, plateau then recover sooner than other areas, but judging by the experience of places that dealt with the virus spread first, like China, South Korea and Europe, it is hard to see us full scale releasing people into social gatherings before June. It is unlikely, in my opinion, that we would be doing any mass gatherings such as sporting events or concerts for the remainder of 2020. I fully expect that release from shelter-in-place will need to be gradual and geography specific, to prevent a large second wave of spread. It is a sacrifice to stay distant for that long and to avoid the gatherings that are the core of our identity. However, history has shown us the cost of ignoring distancing measures with past pandemics. My base case scenario includes a multitude of treatments being released that can help us manage the symptoms when the virus is diagnosed, which helps us to better manage a flattened curve of cases, as we wait for the eventual vaccine. My base case is somewhat elongated versus the optimistic scenario, because I don’t trust that we will have adequate testing available to pinpoint and mitigate the spread, as was done in South Korea. I also believe that decisions made in places like South Carolina and Alabama to delay shelter-in-place will lead to an elongated spread and lack of containment. Under this base case, the recession will extend longer than it should have, but will ultimately recover. It might take several years to recover, but this would be an improvement over the four years that it took to recover from the financial crisis of the Great Recession. We can’t predict the future. This is just an educated guess. We will respond to new data and adjust accordingly.
Fortunately, our strategy for managing portfolios is not dependent on predicting the future. First and foremost, we hold enough in conservative investments to meet your living expenses for many years. We will sell those positions to meet your withdrawals and leave the stocks to recover. Once they recover, we can bring everything back into balance. Whenever we get large price movements, we will make adjustments to your portfolio to try to take advantage. Our goal is to buy low and sell high periodically, without trying to pick the absolute bottom of the market or absolute peak. If we make our changes incrementally and periodically, we can get the majority of the advantage without having to time it perfectly. Nobody ever times it perfectly. Since we already had a game plan in place, before the crisis hit, we don’t need to make large moves in the portfolio. We can ride it out and make only incremental changes to try and improve the eventual post recovery outcome. This requires ignoring your impulse to sell everything when things are uncomfortable and buy back in when things are comfortable again. This impulse is what causes the most financial damage to portfolios long term. We should remain humble in our inability to predict the future and stick to our game plan.
Since my last letter, I have made an incremental move to sell some of our treasury bonds that are up strong year to date and buy a little more gold. The price of gold has stayed relatively steady, but I think it is attractive as an alternative currency holding, when the recovery takes place and we start assessing the impact of large deficits. We aren’t buying it for today, but instead in advance, for after the recovery. If the opportunity presents, I may continue to add to that position. I am also looking for the opportunity to improve the quality of our holdings. There are areas of the portfolio where I would like to have had larger more stable companies. If the market continues to rally, we may have a chance to move into higher quality positions. This is a small incremental change. I am also going to look for opportunities to do tax loss selling to book tax losses that can be used to offset future tax gains and better manage your tax liability.
If you have any questions, please feel free to reach out. I’ll watch the sheep, so you can mind the shepherd.
Stay safe and healthy,
Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®
The views and opinions presented in this article are those of Shane Alsworth only
Investments are subject to market risks including the potential loss of principal invested.
Asset Allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.
Sources: Morningstar/Ibbotson data, Ned Davis Research, BCA Research, Litman Gregory Research