Jen and I have been extremely busy over the past few weeks talking “virtually” with clients to review their financial systems and to discuss how each of them has been impacted by the pandemic roiled financial markets. Much of the discussions centered around the ongoing economic uncertainty and what, if any, changes may need to be made moving forward. Those discussions have been relatively straight-forward since we were able to point to certain strategies, systems and financial instruments we built into their plan that helped to mitigate the recent downside risk. Their plans, other than some minor adjustments, did not require much change.
You know, these calls have been a strong reminder to me just why, particularly in the initial planning stage of any plan, you need to address downside risk to prepare for the possibility of a market drawdown like we saw in March. What I need to talk to you about this week are the calls that we are receiving from folks that, for whatever reason, were reluctant to incorporate risk mitigation into their plan. I find that these folks are struggling with much more anxiety than those who had planned for the inevitability of a market crash.
So, last week I had a scheduled virtual first appointment with a potential client from East Sandwich, let’s call him Dan. He is an avid listener to our radio show on WXTK and a pretty neat guy. Dan is 61, married with three boys in their twenties, and is a cardiologist at a Boston hospital. During our call he shared with me a newspaper article that he had read and wanted my opinion. It stated that the S&P 500 Index had dropped 34% from its pre-pandemic high in mid-February until it hit bottom on March 23, 2020, and that it’s already back up 27% from that bottom as of the day of our call – so in his opinion, since his portfolio, like so many, try to mirror the S&P, he really only lost roughly 7% give or take – right?
Hmmm . . . not so fast.
While the story was factually correct, like so many things in the media, it unfortunately wasn’t complete and didn’t discern the real math of investments. Now if you had investments that were roughly equivalent to the companies that comprise the S&P 500 Index and you didn’t make any changes during this time frame, the real number comes from drawing a straight line from the top of the market to yesterday’s closing number (from February 19, 2020 to April 14, 2020) for the S&P 500. When you do that, the real math the loss would be 16%. This is a frequent error that people unfortunately make when they only look at headlines or anecdotal information. Those headlines or snippets of information don’t account for relative risk in individual portfolios.
Remember, I said the story was factually true. But, here’s the rub. The S&P 500 Index closed at 3386 on February 19, 2020. Its most recent bottom was March 23, 2020 at 2237, which represents a drop of 34%. Since then (as of market close April 14, 2020) the S&P has climbed back to 2846 representing a 27% gain off its bottom. While a quick glance may seem it’s only a 7% loss, the problem is that this is not measuring from the same starting or ending points in time. The straight line from the top on February 19, 2020 at 3386 to the current drawdown level as of April 14, 2020 level of 2846 is a negative 16%. My point is that your own portfolio is what needs to be assessed and relying on broader information may not tell your personal story.
After our discussion on the math, the conversation quickly turned to what he should do going forward. His inclination was to say, well, the damage is done, I might as well sit tight. The problem here is that we are then assuming the market has hit bottom and the slow climb back has begun. But what if it is not.
The fact is that past recessionary markets don’t necessarily bear that out. If you look at the last significant long- term financial market drawdown during the housing crisis from late 2007 to early 2009, the S&P 500 had four negative downturns between 15% and 43% and three positive upswings between 9% and 27% before it finally bottomed out in late February 2009. The straight-line negative number was 57% over the roughly 16-month period. Furthermore, I showed him that if history plays out, if he stays with his current system, he could expect a potential downswing of an additional negative 47% before the bottom is realized. Our Zoom call went silent.
I went onto explain to Dan, that if we look at historical data on past performance combined with the unpredictability we are still facing, to declare that we’ve hit the true bottom appears to be premature. You only need to look at the recent financial news to see a wide variety of opinions as to what the floor of the market is and whether we have hit it. A recent Bloomberg article, “A $645 Billion Manager Says Calling the Market Bottom Is A Mug’s Game”, related five varying views of veteran investors and money managers. Hugh Young, head of Asia Pacific at the $644.5 billion manager Aberdeen Standard Investments, is quoted in the article saying, “I think it’s a mug’s game. Nobody has the answer.” (By definition, a mug’s game is a futile endeavor).
Folks, what we can take away from this is that no one really knows if or when the market has hit rock bottom and recovered until it actually happens – we will know after it’s done. Sure, we can look to history and make estimates based on certain economic factors, but the bottom line is that the markets are unpredictable. So be sure to review your own financial systems to determine the best course of action with the understanding that, as Yogi Berra said, “it ain’t over ‘til it’s over”. Taking no action may actually be dangerous to your portfolio, since there may still opportunities to incorporate downside risk protection both in the short term and in the long term. Like Dan, it is time to do the math.
So as always – be vigilant and stay alert, because you deserve more!
Have a great week and stay safe!
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at email@example.com.
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