Dealing with Unknowability in Markets

Markets seem to have calmed down a bit for the time being.

At the very least, the S&P 500 hasn’t had a 10% move (either up or down) in a single day for a while now. To recap what we’ve been through over the last couple of months:

1. The S&P 500 reached its highest point on February 19th at 3,394.
2. From that point it plummeted 33.9% bottoming out (so far) at 2,237 on March 23rd.
3. Since then it has risen 23.8% to 2,771 as I write this on the morning of April 15th.
4. That leaves us still 18.3% below the high point on February 19th.

This current run up could well prove to be a “head fake” and markets could go back down even lower than they reached on March 23rd. Absolutely no one knows for sure.
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But it is also quite possible that the worst of this downturn is behind us. Again, no one knows for sure but it’s useful to know that the stock market typically begins to recover from a bear market 3-6 months before the economy begins to recover.

Dealing with Unknowability

With that uncertainty in mind, how do we make intelligent, rational investment decisions at a moment like this? We can’t base our investment decisions on anyone’s prediction. The defining characteristic of the future is its unknowability.

As human beings, we’re pretty good at convincing ourselves we “knew it all along.” That is, when we get to look back on it with the benefit of hindsight. But we don’t have that benefit today, and crazy times like we’re living through now remind us just how unknowable the future really is.
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Ultimately, the best tool we have for making rational decisions about an unknowable future is the past. History is our most useful guide. In fact, it’s our only guide. Winston Churchill famously said “The farther back you can look, the farther forward you are likely to see.”

But what can the past tell us about what we should do today? It certainly can’t tell us when this crisis will end. It can’t tell us how this crisis will be solved. It can’t tell us why this virus became such a global pandemic when SARS, Swine Flu, Bird Flu, Zika, Ebola, etc. didn’t.

The most important lesson we can learn from history is not how, when, or why this crisis will ultimately be solved, but simply that it will be solved.

Key Realizations:

If we take that lesson to heart there are a few key realizations and actions that make sense at this moment:

• If this crisis will ultimately be solved, then the market will fully recover everything it has lost and go on to new highs eventually.
• With the S&P 500 at 2,771 it will take a 22% return to get back to its high of 3,394 from back on February 19th.
• Even if that took two full years to happen it would amount to a more than 10% return each year. If it recovered any faster than that the returns would be even better. And keep in mind it’s already recovered more than 23% in just the last 3 weeks.
• Most other markets (international stocks, emerging market stocks, small and mid-size US stocks, etc.) are all down further than the S&P 500 and would require an even higher return to get back to even.

Sensible Actions:

The history of the market has shown that the following actions are the smartest things anyone could do in their portfolio in any of the previous downturns the stock market has ever had:

• Reinvest the dividends you’re getting from your stocks and the interest you’re getting from your bonds back into your diversified stock portfolio.
• Rebalance your portfolio to make sure it’s not accidentally getting more and more conservative (or more and more aggressive) by accident. Because stocks are down today this will have the effect of selling a bit of your bonds (or any other holdings that are not down as much) and buying more stocks (especially the parts of the stock market that have been hit the hardest).
• Contribute more to your portfolio. If you have cash that you know you will not need in the next 5-10 years it’s worth considering putting it to work in your diversified stock portfolio at this point.
• Tax loss harvesting. This is a tactic we use to turn these temporary downturns into permanent tax savings in the future.

For private clients, we’ve been doing these things all along. You may have seen the activity in your accounts over the last couple of months. And we’ll keep doing them when and where appropriate because we firmly believe the market will ultimately recover in full.

We don’t know when that will happen but we know for sure that we want to capture that recovery in our clients’ accounts and these are the best ways we know to do that.