COVID-19 Diary Number 6 (May 30, 2020)

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I started these “COVID-19 Diary” posts on April 1, shortly after the quarantines and lockdowns began.  Much has happened since then, including five posts trying to explain events as they occurred.  Now that those strictures are beginning to lift, it seems appropriate that this sixth post remind readers why things unfolded as they did.

At the time of my first entry, infection and death rates in this country were close to their peak.  Of course, no one at the time could say with any certainty they would not rise higher –– speculation in the media and even within the scientific community in early April was all over the map.  It wasn’t difficult to believe that the United States and the world were on the brink of something like the Black Death, which destroyed a third of Europe’s population in the middle of the fourteenth century.  Leading up to my April 1 post, financial markets, if they were not anticipating the Black Death, certainly feared something pretty awful.  From their highs on February 20 to their lows on March 23, stock prices, as measured by the popular S&P 500 Index, fell a steep 33.7 percent, giving up all the ground gained in the previous two years.

Even in early April, when U.S. deaths and hospital admissions reached their highs, there were hints that the pandemic here, even if it worsened, would not do so at its previous pace.  These were only straws in the wind, but they were enough to convince some investors to reconsider, if only partially, their earlier decision to anticipate the worst –– not necessarily to become optimistic, but to reassess their earlier degree of pessimism.  With that, stock prices began to lift off their lows.  By mid-April they had regained almost half the ground they had lost in February and March.  Yet it was about then that evidence emerged showing how economically devastating the lockdowns and quarantines were becoming.  Initial claims for unemployment insurance, for instance, were running at over 3 million a week, more than ten times anything anyone had ever witnessed.

The juxtaposition of stock market gains with such difficult economic news sparked media speculation.  Some stories claimed mystification by what they termed the “decoupling” of financial markets from economic reality.  Some headlines, in a style reminiscent of conspiracy theories, suggested that, somehow, Wall Street was benefitting at the expense of the rest of the country.

In retrospect, none of the market’s actions seem strange at all, and for readers of these blog posts they should not have seemed strange even as they were happening.  Markets, after all, had priced in bad news long before any bad news was available.  By the time that anticipated bad news had arrived, many investors had begun to look beyond the economic pain of the emergency.

Now, early in June, the course of the disease and the steps to reopen the economy seem to have validated the market’s April reconsideration of its earlier pessimism.  But the future still holds considerable uncertainty.  Infections will doubtless rise with the economic re-opening.  And if they rise to levels that require a reintroduction of quarantines and lockdowns, then markets will have lost the basis for their optimism, and they will retreat accordingly.  Even if the level of infections remains manageable and there is no re-imposition of severe anti-virus strictures, the economic recovery might still disappoint.  Though politicians paint a pretty picture, many restaurants, retail facilities, and other firms may never reopen, thus denying the economy those facilities and jobs for their former employees.  Recovery then will demand more than just a resumption of former activities; it will demand rebuilding, a much slower and more arduous process. I do not doubt that the economy will eventually recover, but the speed of the recovery remains very much in question, and market prospects hinge on that consideration.

Stock and bond prices, then, remain vulnerable, both to bad news on new infections (especially if they require a relapse into quarantines and lockdowns), and to the pace of recovery.  The inevitably uneven flow of information will, unavoidably, create moments of fear in the investment community and these will drag down stock prices.  But because the economy will eventually recover, these moments should present long-term buying opportunities.  But I remind readers of this blog that those opportunities belong only to those who can invest over a longer time horizon.

Covid-19 Diary Number 5 (May 26, 2020)

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The Labor Department’s jobs report for April offered official confirmation of what we already knew: the U.S. economy is in deep trouble.

Though this collection of data is the worst since the Labor Department began this statistical series in 1957, the official report probably understated the extent of the economy’s troubles.  It showed that the nation’s payrolls fell by more than 20 million workers last month and that the number of unemployed increased by 16 million, to 14.7 percent of the country’s workforce, and that some 4 million of the men and women who lost their job last month have given up trying to find new work.  At the same time, a different Labor Department report announced that in the last seven weeks almost 40 million Americans applied for unemployment insurance, implying an unemployment rate of well over 20 percent, a figure not seen since the Great Depression.

The details included in the Labor Department report offer new evidence of how widespread is the economic pain:

  • Payrolls dropped in all but 5 of the 176 work categories and subcategories used by Labor Department statisticians.
  • Of the few sub-categories that showed an increase, the only one worth mentioning is the 4.7 percent rise in “warehouse and distribution center” employment. (There should be no trouble guessing which firm dominates that.)  A miniscule rise in employment for “messengers” and what the Labor Department refers to as “other information services” are doubtless related to the rise in deliveries.
  • The only other area reporting a rise in payrolls was the federal government, where payrolls increased a mere 1,000 on a base of close to 3 million employees, a rise of less than one tenth of one percent.
  • Other government areas made cuts –– local government in particular –– trimming payrolls by some 800,000 workers, or some 5.4 percent, mostly teachers and school administrators.

The private sector, which employs some 83 percent of the country’s workers, saw its payrolls drop some 19.5 million in April, a stunning 15.1 percent:

  • Manufacturing dropped 1.3 million workers, 10.7 percent of the number they employed in March.
  • Construction payrolls dropped by just under 1 million, a 12.8 percent fall from March.
  • Services, a large sector, were hit harder, with a loss of more than 17 million jobs, or nearly 16 percent, from March.
  • Within the services area, the greatest damage was in “leisure and hospitality,” where payrolls fell by almost half or about 8 million.
  • The relatively small subsector of childcare shed about one-third of its employees –– slightly over 1 million.
  • Considering that Covid-19 is fundamentally a medical emergency, it is striking that healthcare payrolls also fell, by some 2 million, or 8.7 percent from March levels. Apparently the country’s concentration on the virus has forced a cut in other medical services, especially elective surgery.

When the May jobs figures become available June 5, they will show still more economic damage. Probably the erosion from April to May will fall short of the steep slide reported for last month, but the data will still describe a worsening situation. Markets may take this news hard, because investors have been focusing on how the economy might come back in a re-opening.  But a retrenchment in the face of a hoped-for re-opening might provide a buying opportunity. Because a quick and robust recovery remains a very open question, investors would do better not to focus on market timing but concentrate on the longer-term future, which, despite today’s intense fears, provides greater assurance of a successful market recovery.

COVID-19 Diary Number 4 (May 5, 2020)

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The president and several governors have begun considering, and in some cases beginning to end, the worst of the lockdowns and quarantines in the effort to reopen the economy.  It is none too soon.  As readers of this site know, the strictures to “flatten the curve” of infections and hospitalizations threaten economic collapse.  Dr. Anthony Fauci has described these strictures as “inconvenient.”  No doubt he means to sound sympathetic, but the lockdowns and quarantines are far worse than inconvenient.  These rules have attacked the essence of people’s lives, perhaps not as medical people and epidemiologists understand it, but surely as most people do.  It is a step far beyond inconvenience when some 30 million Americans have to apply for unemployment insurance in the space of five weeks!  That is almost 20 percent of the country’s workforce, a proportion that will only increase the longer today’s lockdowns and quarantines stay in place.

California has led in outlining the move back to work and it has identified specifics that would allow it.  That huge state is not alone.  President Trump and other states – governors in the Northeast acting in concert – have also indicated a path to economic reopening, as have various think tanks and advisory bodies.  These suggestions vary in detail, but each effectively foresees a three-stage process through which public health developments  — what the White House calls “gating criteria” — will allow a relaxation of today’s constraints and hopefully begin a return to former levels of prosperity.

Presently we are in the first phase and have been since mid-March. Here are its salient features:

  • People have been pressed to stay at home regardless of their vulnerability or symptoms.
  • Businesses have been shuttered, except those designated “essential.”
  • All states have banned large gatherings.

Without easy widespread testing, these and other aspects of this strict phase were the only way to guard against random infections and run the risk of overwhelming existing healthcare facilities.  Though the lockdowns and quarantines have been necessary, they have thrown millions of Americans out of work, most especially in the retail and hospitality industries, but also in manufacturing and professional services.

Current plans call for a continuation of this phase until at least mid-May.  Easing can occur, the authorities say, only when a state or region can see specific changes, the most significant of which are:

  • An ebb in new cases and a drop in hospitalizations. The redoubtable Dr. Fauci has characterized this easing as a concerted drop in new cases and hospitalizations over a 14-day period (the time over which an infected person will develop symptoms).  That hopeful sign, he and others have said, has begun to be in evidence, though no one is making any promises.
  • A transition would also depend on the ability to do widespread, same-day, point-of-care testing, even of the asymptomatic, in order for authorities to isolate only those who are sick. One researcher said an ability to do 750,000 tests a week would be a reasonable number.
  • Easing would also have to wait until healthcare facilities were considered adequate to handle a new spike in cases should it occur, and the necessary step of setting up contact tracing (as New York State has already begun) of those who have been infected.

Different states or regions will take such reopening moves at different times, and some states are coming up with their own interpretation of these steps—Georgia and New York being different examples; Georgia as of this writing opening up, while New York is still pretty much in lockdown.  Where they do open up, the authorities could still impose restrictions.  Some that have been proposed are:

  • Individuals identified as vulnerable would be urged to isolate, and there is some discussion of subjecting them to GPS tracking.
  • Rules would still forbid large gatherings
  • Restaurants would have to reconfigure to allow socially distanced (however defined) seating.
  • Staff at restaurants and other retail outlets would wear gloves and facemasks, and perhaps more protective gear.
  • Offices might reconfigure to make the by now famous six-foot separation distances easier to maintain.
  • Offices and factories might include temperature scanners as well as firm-wide testing for Covid-19 antibodies.
  • Airlines might forbid any passengers until six weeks after virus dissipation. Most major US airlines are already making passengers were masks during flight.
  • Sanitizer dispensers will become even more ubiquitous.
  • State parks and other facilities will reopen, but only to people who wear masks and arrive in groups of five or less (as Texas has already mandated).

The full reopening of economic activity — the final, third phase — would wait for a vaccine.  The authorities in California and elsewhere also include what they call “herd immunity” as a trigger for this phase.  (This is a slippery term that appears to mean that the population has had widespread exposure to the virus, that those who will succumb to the virus are no longer a concern, while, presumably, the majority of the population has developed immunity.)  Only then would the authorities allow us return to our former economic lives, and only then would the economy have the opportunity to recapture its pre-pandemic prosperity.  But forecasts on vaccines are by definition difficult.  Researchers are hopeful they can shorten the timeline, piggybacking on previous research on other viruses.  Estimates now say a vaccine for healthcare workers may be available by late this summer, or early fall, and by early next year for the general population – a long time to wait for full employment.

If this reopening proceeds in a promising way, it can only help financial markets build on their recent gains, most of which have come in anticipation of some progress on the virus and thus a good promise of economic relief.  There is the possibility, however, that given the way things go in the real world, some mishap (say, either a rise in cases or a miscalculation on easing restrictions) would create a period of market fear and accordingly a retreat.  As always in such events, good investors will keep their eyes on the longer term, and resist the temptation to give into fear.  Such a fearful moment might even present a buying opportunity, though, as my readers now should know well, I never advocate trying to time the market.

 

 

 

 

COVID-19 Diary Number 3 (April 20, 2020)

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The unemployment rate reported by the Labor Department for March understates, by a long shot, the nation’s economic pain.  According to the official report, non-farm payrolls last month fell 701,000 and the rate of unemployment rose from 3.5 percent in February to 4.4 percent. The actual figure is that closed businesses and quarantines likely reduced payrolls nationwide by 12 million in the last the last two weeks of March alone.  During that time other Labor Department reports show that more than 10 million applied for unemployment benefits, something for which not all the unemployed qualify.  Because the workforce of the United States numbers some 165 million people, those new claims at least added some 7.5 percent to the existing unemployment rate, conservatively making the more likely number of unemployed in March closer to 12 percent of the existing workforce.  The figure has grown in April and will grow as the emergency constraints remain in place.

Lovers of conspiracies will accuse the authorities of intentionally understating the economic pain.  But the real reason is far less dramatic.  The Labor Department missed the extent of Labor Force damage because it bases its calculations on two surveys that are taken in the middle of each month, one of households, the other of employers.  The first asks a sample of the population whether they are working, and if not, whether they want to work.  Those working, and those who are out of work but seeking a job, give the Labor Department a fix on the size of the nation’s willing workforce each month.  Those out of work but who seek it count as the unemployed, which the Labor Department states as a percentage of the workforce. The second survey asks employers about the number of people on their payroll.  Because the worst effects of the lockdowns and quarantines did not develop until late in March, the Labor Department’s mid-month surveys simply missed most of the impact of the situation.

That will not be the case for April.  The mid-April surveys will capture the full brunt of what has already happened.  But these surveys will mislead in a different way: In addition to workers who lost their jobs in early April, we will see the accounting for the tremendous drop in payrolls that occurred in late March but which that mid-month surveys missed.  The report for April will then show a shocking surge in unemployment, much of which really occurred in late March.  Observers will be led to believe the sudden damage was all done in April and thus see an acceleration in labor market damage that probably will be far in excess of what is likely for the April part of the surveys, though the ongoing damage will undoubtedly become more severe.

I have described here a technical problem with statistical techniques that in most environments are more than adequate for the tasks set to them.  But in this pandemic environment, the misleading nature of these figures can have real-world effects on perceptions of the state of the economy and on public as well as business confidence.  The burden is on the Labor Department and the Trump administration to clarify the figures so the public is not misled in April and again in May when the responses to the April survey become available.

COVID-19 Diary Number 2 (April 6, 2020)

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Though no one can yet say how the virus will continue to develop in the U.S., and therefore how the markets will go, a review of the past few weeks can allow this conclusion (with apologies to Winston Churchill at the end of the Battle of Britain): This is not the end or even the beginning of the end, but it is the end of the beginning.

Whenever markets suffer a shock – a collapse somewhere in the economy, natural disaster, war – participants panic.  This happened in March as the extent and severity of the Covid-19 pandemic became apparent.  Such panic could of course return if markets were to suffer another terrible surprise, but their recent behavior suggests this beginning phase of the market correction seems to have ended:

  • Equity prices have clawed back some of the ground lost to March’s panic. Stock prices fell precipitously between February 21, and March 23, with the benchmark S&P 500 stock index sliding almost 35 percent in just some four weeks, wiping out all the impressive gains of the prior three years.  Since then, investors seem to have recovered the sense that perhaps pricing had anticipated the worst, especially since the Federal Reserve (Fed) and the government have initiated policies to mitigate if not erase the recessionary effects of the measures needed to fight the spread of the virus. Pricing has begun to improve.  Stocks have risen some 19 percent from those lows, still some 21 percent below the highs of February, but a sign that panic has passed for the moment. 
  • Bond markets, while still fearful, remain relatively stable. On the first news of pandemic, Treasury yields fell precipitously, with the yield on the 10-year note dropping from just under 2.0 percent at the end of January to just over 0.6 percent by mid-March. To a large extent, the move reflected the Fed’s efforts to drive down all interest rates and bond yields. A flight to quality also was an element here.  As investors sold off bonds issued by entities with lesser credit ratings and put the proceeds into presumably safer Treasury issues, the yields on all other bonds actually rose, widening the yield spread lesser credits offered over Treasuries from a little over 3.5 percentage points late in February to just over 10.5 percentage points late in March.  This was not as high as the 20 percentage point spread that prevailed for a while in the Great Recession of 2009, but it’s hardly a sign of confidence. (This post will brief you on how bond prices and yields interact.)  The past few weeks have seen only modest improvement.  these yield spreads have declined to some 9 percentage points –– hardly much improvement but nonetheless a tentative sign of relative calm.
  • Commodity markets tell a similar story to bonds.As the lockdowns and quarantines effectively shut down the economy, industrial materials prices dropped quickly. Copper prices illustrate the common story, falling by almost 20 percent from early to late March. Oil prices did worse, falling some 40 percent during this time, though extra pumping by Saudi Arabia (because of a dispute with Russia) exaggerated the general price retreat. Prices of oil, copper and most industrial materials have since risen slightly –– again, not a sign of confidence but at least a halt to the earlier panic.
  • Currency markets, in contrast, have all but corrected their earlier panic.  When the seriousness of the pandemic first became evident, money moved toward dollars, as it does in almost every emergency.  A global index of the dollar’s value rose some 5 percent, but has nearly returned to its level of early March.  Some might interpret this as a sign that Covid-19 infections in the U.S. have risen, but on a per-capita basis the American infection rate is no worse than in most developed countries and a good deal better than some.  The movement away from the dollar speaks to a lessening of panic.

All this could change if COVID-19 changes its course.  If it worsens, panic could reappear, and the markets would return to their levels of late March or even lose more value.  But if the effects of the disease ease and promise a return to more normal levels of economic activity, the relative calm of recent weeks suggests that markets could regain ground quickly.

COVID-19 Diary – Number 1 (April 1, 2020)

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A reader suggested that while this pandemic continues, I keep an open diary on this site with frequent short entries focusing (though not exclusively) on investment and the markets. This is the first of these posts.

Markets are less concerned about the virus itself than with the recessionary impact of the lockdowns and quarantines.  That perspective points to two considerations:

  1. Actions by the federal government, and to a lesser extent states and cities, to lessen the recessionary pressure.
  2. Because the longer the lockdowns and other restraints remain in place, the deeper into recession the U.S. economy will sink and the longer and harder it will be recovering, markets necessarily also consider how long this period of restraint will last.

Washington—that is, the government and the Federal Reserve––has now delivered large (more than two trillion dollars) and well-crafted policies to deal with the recessionary dynamic. While these moves cannot ensure the economy will escape the pain of a recession, they do offer good reason to hope that the future will be less severe than it otherwise might have been.  The markets rallied in response, actually in anticipation of this welcome news.

The news on the duration of lockdowns and quarantines is less encouraging.  President Trump has given up on his “hope” that the nation could get back to work by Easter, and he extended the advice to keep things shut down until April 30.  He may have to extend it further because new Covid-19 cases are multiplying in the U.S.

  • The global picture does offer some hope. The tracking system administered by Johns Hopkins University reports that new Covid-19 infections peaked on March 27 at 67,400 and in the following two days fell about 10 percent.  But we must keep in mind that this picture of abatement is really tentative.  At other times we have seen such improvements only to face a new surge.
  • For the U.S., the picture is less encouraging. On March 31, the World Health Organization reported that the nation suffered some 19,332 new infections, nearly five times the number reported on March 27.  Yet these figures may not be as bad as they appear.  In just the last few days, the country has made considerable headway in testing – not as much as the experts say is needed, but an improvement nonetheless.

Investors should keep in mind that the nation will survive this pandemic, as will most of its businesses.  Those who bought equities for the long term (which, as so many of these posts have emphasized, is the only way to buy stocks), should keep that “long term” in mind and hold on for the inevitable recovery.  Panic selling now will only deprive you of the opportunity to take part in that recovery.  For those who have cash, the present market setbacks presents buying opportunities. But because no one can know when the pandemic and its economic fallout will end, it is not possible to pinpoint the best buy.  The smart approach would be to invest in stocks piecemeal, and over time –– perhaps on each major market reverse.  Investment professionals call this “dollar cost averaging”.

 

 

 

The Computer’s Role in the Recent Wild Market Swings

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Computerized stock trading has played a not-insignificant role in recent violent stock market swings.  Of course, behind these swings are the perennial drivers of market lurches: fear and greed.  Fear rules whenever investors feel insecure or uncertain, but it’s greed’s turn when investors judge that the fear has created a buying opportunity that despite uncertainty and insecurity, they feel they cannot afford to miss.  But computerized trading exaggerates what otherwise might be significant swings into wild volatility.  We have been seeing a lot of this.

The computer’s role exaggerates market swings because most if not all of the algorithms running these programs react to the momentum of the market.  If investors begin selling out of fear and stock prices fall at a particular rate or beneath a certain point, the computers “see” further losses and “order” even more sales, thus ensuring that further losses take place.  Investors  rushing to buy a stock will trigger the computer programs to join in.  These investor moves, once they prompt the algorithms to act, become self-fulfilling and greatly exaggerated.

For those who find this unnerving, here are four things to keep in mind:

  1. For the computer, eternity begins and ends each day. They go with the momentum until the market closes (or, less likely, something like human action alters the momentum despite the influence of computer trading).  The computer action does not follow from one day to the next.  
  2. Though computerized trading exaggerates up and down moves, it has no effect on prices over time. Such trading can be an irritation for the fundamental investor seeking to meet the basic objectives often referred to in these posts, but don’t consider it anything more than that.  The market in the closing weeks of 2018 certainly demonstrated this:  Computerized trading pushed the downdraft in stock prices much further than it otherwise might have gone, and then exaggerated the upswing the following dayThe same thing is happening now.
  3. Individual investors who try to gain from computer-induced swings by buying and/or selling stocks ahead of the swings are as likely to lose as to win. Traders buying and selling algorithmically make money because computerized trading enables them to move blindingly fast –– faster than most professional investors and certainly faster than any retail investor –– that would be you.  (In fact, most of these operations have their computers physically near the exchange, because a profit opportunity can be missed in the less-than-instantaneous time it takes an electronic order to reach the exchange from, say, an office in Connecticut.)  Even at such speed, algorithmic traders can only make money by squeezing pennies or less out of a single transaction; it is worthwhile for them because they deal in huge stock volumes.  No individual investor can do this.
  4. Computerized trading violates a fundamental rule for the retail stock investor: Even without the added volatility of computerized trading, stocks exhibit considerable volatility. This is a fundamental aspect that should warn investors off stock investing if there is any chance they will need their invested money in a hurry.  If you cannot wait for the  market’s ups and downs to cancel each other out and give you the long-term positive gain of stocks, then you should not be in them in the first place.  Better to be in bonds or savings accounts. 

 

Market Panic Over the Coronavirus

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As of this writing, markets have fallen more than 10 percent from their highs, almost entirely in a panic over the coronavirus.  It seems the American public has also shown signs of panic. Emergency food packs have disappeared from store shelves and some towns have objected to sick people getting treatment locally.  While some investors are concerned that the virus will spread across the U.S., most of the market panic thus far centers on the economic ramifications of the virus. There are three concerns:

  1. First is that economies, China’s in particular, will suffer because of widespread sickness in the country and drag down the global economy, even if countries like the United States can contain the spread of the disease.
  2. Second is that interruptions in supply chains, again notably from China, will hamstring business around the world and set economies back, even those that can contain the coronavirus.
  3. Third is that business managers will hoard inventories, either of supplies or finished goods, which would create shortages in supply chains, even when there is no real shortage of the goods in question. (For this insight, I would like to thank a wise reader who asked about that possibility.)

This is not the first time markets have suffered in the face of — and fear of — pandemics.  The spread of SARS between 2002 and 2004 created notable market retreats within what was otherwise a bull market.  In 2009 an influenza pandemic took the lives of over 200,000 worldwide and caused momentary panic in a market that was already struggling to recover from the 2008-09 financial crisis.  In 2012 the MERS pandemic produced market setbacks for brief periods.  These experiences, and the current market reaction to the coronavirus, offer investors a lesson in how to respond.

The first thing to understand is that it is impossible to predict the extent or duration of events like these.  Many commentators will try, and experts will offer estimates. While the experts’ guesses are better than those offered by the man on the barstool next to you, they are guesses nonetheless.  Keeping this in mind, there are three scenarios about how things will work out, each with its own investment implications:

  1. The disease sweeps across the world, causing widespread death and disruption. This is the basis of the public fears that are presently gaining momentum.  In this case, the investment implications are straightforward:  You — everyone — have more to worry about in such a situation than wondering about your portfolio.  Sell out, if you think that cash or treasury securities are safer in such a world than stocks or bonds.  (Though they probably are safer, they are far from safe in that environment.) Whatever you do with your money, see to your health and that of your loved ones. The money is secondary.
  2. The disease runs its course, as did SARS, which was a far more ruthless killer than today’s coronavirus. In this scenario, the abatement of the health emergency will prompt a market rebound and an economic recovery as global supply chains quickly reboot. The present coronavirus, beginning as it did in China, may hasten the shifting of supply chains away from that economy, something that was already under way in response to the U.S-China trade war.  (That is an interesting question and perhaps food for another blog post, but it is a separate matter from today’s panic.) Whether from China or Vietnam or elsewhere, the supply pipelines, literal and metaphorical, will quickly resume once this disease ebbs.  If this is the case, the current market retreat presents a buying opportunity. Of course, purchases made in anticipation of such a rebound run the risk of suffering further declines should the virus’s worst effects linger.  Therefore it might be prudent to make purchases gradually, in increments over time.  This way you will be in position to enjoy the rebound should things change quickly, but will also have funds to buy at still lower prices should the disease take longer to run its course.
  3. The disease neither runs its course nor sweeps across the world. The virus becomes a fact of life, much like HIV did over a long period from the 1970s, when it first made its appearance.  Should things unfold this way, the market would not offer the sudden rebound described above.  It would instead recover more gradually as investors come to terms with this disease as an ongoing risk in life, like cancer or HIV or heart disease, or a long list of horrors that people are aware of and simply accept.  To an extent, this scenario, too, would offer a buying opportunity, though it would not present a sudden market rebound described above.

The odds presently suggest that the market, as well as the economic responses, will mostly resemble the second scenario. This was the case with SARS, MERS, and the influenza pandemic of 2009.  But because the behavior of viruses is so difficult to predict — impossible, in fact — any such response would come with considerable risk and should not involve a large part of any investor’s assets.

As this event continues to develop, I will update as necessary.

A Question of Objectives and Asset Allocation

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I recently received a question accompanied by an interesting description of an asset allocation debate.  It gets to the nub of several investment principles underlying Bite-Sized Investing.  To put my response in perspective, I quote  from the communication.

“A few years ago, I bought stock for my retirement account in one of the great computer-related companies – let’s call it HAL – at somewhere around $55 [a share] and watched it grow to about $140.  I was pleased with myself.  But in my year-end meeting with my broker [. . .] we discussed my retirement accounts (an IRA and one other) [. . .]  The broker wanted me to buy some bonds, which I reluctantly acceded to, but they also pressed me to sell all of my HAL stock and take my profits.  I resisted: I didn’t need cash, and because I still work [. . .] I only withdraw the minimum from my retirement accounts as dictated by law.  But they pushed me to sell, and we finally compromised that I would sell half the stock.  I did, and the stock has now gone past $180 [a share]. (I realize that the stock – any stock – could have gone south.)  I feel that I let myself be talked into a decision that I now regret.  The broker I deem to be a good guy, though not perhaps a brilliant stock-picker.  I don’t think he acted for the purposes of churning my account, but . . . I also have a friend who says that when he buys a stock, he does so without any intention to sell, because the market, in the end, prevails.

“Thoughts?  Advice?”

 There is a lot going on here.  Before suggesting a course of action, here are four relevant points:

  1. I agree with you that your broker was not trying to churn your account. If he were doing so, he would have suggested many more trades, something like diversifying your HAL holdings into several other stocks or making many more changes than he did. On the contrary, as I will make clear in the following points, I believe he was acting from the best of motives, perhaps misplaced, but otherwise honest and in some ways quite reasonable.
  2. I have always stressed diversification, which makes me sympathetic to your broker’s suggestion to sell all or part of the “HAL” holding. Rather than an outright sale, I would have sought diversification by bringing down your “HAL” exposure to no more than 5 percent of your assets.  If you have an abundance of assets relative to your needs (and so could afford to risk a greater part of them) I would have upped that percentage to 10 percent, but not more.
  3. Your broker could have been reacting to the designation of your account as a retirement vehicle, especially because of the legal requirement that you must draw on your IRA after your 70th+ birthday (now 73). Typically, as a person nears retirement, investment advisors of all kinds will recommend selling stock, especially the more volatile ones, in favor of bonds and more stable, higher dividend-paying stocks.  This way, the portfolio will throw off the income a person presumably will need in retirement, and because it is more stable, the portfolio will also avoid the risk that the owner will have to sell when prices are deeply depressed. There can be little doubt that your broker had these needs in mind when he gave the advice to move from “HAL” into bonds, even though you are still working, have no need to draw on these assets for living expenses, and do not expect to have that need anytime soon.
  4. Your broker may have been under some pressure from his headquarters as well. Not too long ago, the Department of Labor threatened to designate brokers as fiduciaries, something that would have made them liable for legal action should their advice have resulted in a loss.  At the same time, the Labor Department offered guidance about what policies might be acceptable and so presumably might have protected the brokers from legal problems.  Those policies included the kind of retirement account strategy described in the point above. Though the Labor Department ultimately decided against this approach, brokers no doubt worry that the regulators will return to such thinking and so in the meantime strive to keep their advice in line with what the Department once considered acceptable.  And they might do so regardless of a client’s specific needs or desires.

I recommend two ways to cope with this situation:

  1. Make your particular circumstances clear to your broker. He should have no confusion that you have no intention of retiring anytime soon and that as a consequence he should, despite your age, treat your retirement account as he would that of a younger individual with plenty of time remaining before needing to draw income from the assets.  You might explain that you have no intention of ever retiring and that, whatever the label on the account, you mean it as a legacy for your children or other heirs.  It might help to clarify this arrangement in writing so that he can attach it to your account.  That way he can save himself from pressure from his firm, either on policy or legal grounds, and also bind his successors and assistants to your intention.
  2. You might also set up a separate account for the after-tax proceeds of what you are legally required to sell from these retirement accounts. Because such an account would not carry the retirement designation, it would avoid all the seeming requirements pressing on your broker with your other two accounts, thus relieving him of any need to follow company policy on retirement accounts or Department of Labor direction.  In this separate account you could:
    • Repurchase some or all of the “HAL” or Hal-like stocks sold from your retirement account.
    • Because the sale from your retirement account would be free of capital gains taxes, this transaction would not incur tax liability.And while you would benefit from taking all the earlier gains from your retirement account(s) tax free, the new, higher price in this new account would set a higher price base so that the taxable capital gain from any future sale would be lower than if you had to calculate it from the original price you paid when you bought it for your retirement account.
    • As a further safeguard, make this account strictly non-discretionary so that your broker can only act on your instructions.

The Good Professor’s Measure

people inside building

Yale University Library.  Photo by KML on Pexels.com

A reader and good friend recently sent me an article by Robert Shiller, Nobel Laureate and Sterling Professor of Economics at Yale University.  In it, Prof. Shiller uses his own tool for evaluating markets, the so-called C.A.P.E. price-earnings ratio, to make the case that markets are overpriced and that the current market rally is running on emotion. Prof. Shiller is an impressive man, with credentials to boot.  His warning that a market correction is in the cards may well be correct, but his prediction gives me the opportunity to warn readers, once again, about the hazards of forecasting and trying to time the market.

The Shiller C.A.P.E. ratio has been around for a long time.  It differs in two ways from the conventional price-earnings ratio discussed here.  First, where the conventional ratio divides stock prices by recent or future earnings, the Shiller ratio divides the price of stocks by their average earnings over the last ten years.  Second, unlike the conventional ratio, the C.A.P.E. adjusts the earnings to take inflation into account.  Shiller argues that his two adjustments uncouple his ratio from problems associated with the conventional ratio, especially with respect to recessions.  When the economy pulls back, corporate earnings typically drop faster and further than stock prices, so that at market lows, when people should be buying, the conventional price-earnings measure looks high, suggesting that stocks are overpriced.  Shiller’s measure, because it uses long and deflated averages, gets away from this misleading effect.

It seems strange to adjust the earnings for inflation.  After all, stock prices – the point of comparison – are not adjusted for inflation.  The use of a long average introduces other problems.  Because earnings rise over time, his use of a ten-year average tends to make the C.A.P.E. ratio look high and the market therefore look overpriced much of the time.  Together, these effects make the C.A.P.E. measure give a sell signal even when much else suggests that stocks are a good buy.  Here are three illustrative examples:

  1. C.A.P.E’s implicit pessimism was certainly evident during the earnings and market surge between 2017 and 2019. Leading up to 2017, earnings had disappointed, biasing downward the ten-year deflated earnings average.  As a consequence, as 2017 drew to a close the C.A.P.E. measure indicated less attractive market valuations than at any time since 2001.  C.A.P.E. followers would have sold and missed the better than 20 percent appreciation in stock prices over the last two years.
  2. The recovery from the great recession tells a similar story. The C.A.P.E. ratio showed a buying opportunity in 2009, and it was a good opportunity.  The market rallied in the years following the recession’s end even though the economic recovery was disappointingly slow.  But because the ratio’s use of a deflated ten-year earnings average could not fully capture the post-recession surge in earnings, the Shiller ratio by the end of 2013 showed even less attractive stock valuations than at the start of the great recession.  Investors following the ratio would surely have sold and missed the huge gains of the next six years right up to the present.
  3. In 1990, the C.A.P.E. ratio showed the least attractive valuation in sixteen years. Yet the 1990s saw great market gains of some 274 percent!

The media’s treatment of Prof. Shiller’s efforts adds to the damage of these misleading signals.  He is a famous man and receives attention from financial journalists, who broadcast his warnings; several publications have given him his own platform.  When his early sell signals prove mistaken, people naturally forget them amid the endless flow of market commentary.  And when after several false warnings the market does correct – and there is always a market correction on the horizon – the media says, in effect, that he “got it right again,” or words to that effect.

My point is not to criticize Prof. Shiller and his efforts to chart market valuations.  He is a thoughtful and insightful man.  However, his is just one of many measures, all of which have their drawbacks.  We should not ignore Shiller’s work, despite the C.A.P.E. ratio’s sometimes misleading nature. But we should keep in mind that his measure’s failings show, compellingly, how difficult it is even for even the best-educated minds to forecast market moves and why timing the market is so dangerous, especially using a single measure.