The COVID-19 crisis is continuing to reshape the globe as governments, businesses, and families alike learn to adapt to a socially distant economy. Meanwhile, investors are still working to understand how the pandemic will affect financial markets now and over the coming years.
We recently had an opportunity to conduct a Q&A session with Apollo Lupescu, Vice President of Dimensional Fund Advisors. For those who missed the live webinar presentation, we have provided notes summarizing the discussion below.
Our conversation centered on the financial implications of the current crisis, including:
Will the crisis cause inflation, further market declines, or troubles for the mortgage market?
Does the COVID crisis push optimal portfolio allocation toward gold and crypto (and away from international markets)?
How does the present crisis compare to some of the greatest in history and how have markets always found a way to bounce back?
Keep reading for a summary of our key takeaways. The call centered on calmly adhering to fundamental, historically rooted insights about how markets function even as events seem to be creating unprecedented disruption. The global economy has adapted to bounce back from unique macroeconomic crises in the past, and it will do so again.
GMW Summary Notes From Q&A with Apollo Lupescu: Monday, March 30th Town Hall
Question: While people are worried about financial markets, one of the items I do want to cover with you is the underlying structure of financial markets. Specifically, how is the overall health of the financial system? How are markets functioning under all the stress?
Answer: Markets are well-functioning, businesses are fairly valued, and the concept of buyers and sellers still works – for every person who wants to sell a stock or mutual fund there is a buyer, there are firms seeking opportunities. Free markets are resilient because we are.
Question: Something we often hear from investors is how current events are unprecedented. While things are certainly different in this crisis, can we look to the past for guidance and draw some lessons so that we can better cope with the current situation?
Answer: COVID-19 is not as unique as you may think if you review historic events, including a) the great recession; b) the dot com bubble; c) the 1987 flash crash; d) the 1973-74 energy crisis; and e) the great depression.
The Great Depression included the 1929 crash and then another downturn of 36% in 1939-40. By 1940 the stock markets were the last place people wanted to be invested. Many felt the end of the world could be coming with the start of the 2nd World War. Yet the market returns in the “dark years” of 1941-45 had an annualized market gain of 17% due to the retooling of the industry to make military equipment, uniforms, and more.
Question: Given these perspectives on the past and current conditions, the obvious question is what should we, as investors, do next? What are the actions that we should take going forward?
Answer: Investors must consider the appeal and fallacy of market timing, the role of bonds in a portfolio, international diversification, rebalancing opportunities, tax-loss harvesting, and long-range profit potential of companies. We must manage our expectations. Your portfolio may behave differently from what you see on the daily news - professionally managed portfolios typically do not just invest in the S&P 500, Nasdaq, and the Dow 30.
Client Q&A Questions
Question: Has the market already priced in the forecast of 30% unemployment and possible lockdown continuing for months? These are truly unusual circumstances. Once those realities are widely believed and priced in, is the market likely to go lower?
Answer: Markets are efficient, and they have priced in what is known. For every seller, there has to be a buyer.
Question: Is trading by computers causing the violent swings in the market? If so, does this distort the bargain between stock buyers and sellers?
Answer: No, computers are programmed by people. Computers allow markets to trade more efficiently, narrowing the gap between buyers and sellers by making the execution transactions easier and faster than ever. It’s the more rapid transfer of information through the internet and the ubiquity of computers and smartphones that is causing people to react to news almost immediately which is primarily responsible for the increased volatility.
Question: Will supply-chain issues cause inflation, and will it be long-term or short-term?
Answer: There is currently a retooling of industry happening. Just like in World War II where factories began making jeeps and tanks for the war, so too are we making changes to what is needed.
Question: How do you decide when to invest more in the international markets than in the US?
Answer: The US market (the total value of all the publicly traded companies in the US) only has 54% of the world’s market value (the total value of all the companies worldwide that are publicly traded). Therefore, you need exposure to all the markets in order to dampen volatility. I expect there is some natural bias toward US companies reflected in your portfolios.
Question: Should I have some gold, silver, and/or crypto in my portfolio?
Answer: In 1973 the US dollar departed from the gold standard agreed to at Bretton Woods. As a result, the impact of gold now has no real bearing. That said, you do own gold and silver and other commodities in your portfolio through [stock] ownership in the mining companies around the world. The cryptocurrencies are used for enabling quicker [and decentralized] transactions but again is not necessarily something to hold.
Question: What do you see coming for the mortgage industry and the very real struggles it is facing right now? Is the Fed buying MBS a good thing right now?
Answer: The stimulus packages put forward by Congress, the Fed, and Treasury are all in sync and working together to assist our workers, businesses, and the economy as a whole. Bank balance sheets are significantly stronger than in 2008. As a result, we do not see the same stressors.
Question: How concerned should we be about the impact of companies (especially small companies) going out of business?
Answer: The small companies you own in your portfolios are actually relatively large companies and not the average small company you are hearing of potentially going out of business. Therefore, although some of the small-cap companies in our portfolios may become stressed because your portfolios own so many the impact is mostly mitigated.
Takeaways: Tried and True Wisdom for a Time of Crisis
The webinar’s insights center on a key theme: the COVID crisis constitutes a very real shock to the economy, but nothing about current events should lead us to doubt our hard-won historical lessons on the resiliency of markets, the efficiency of asset pricing, and the adaptability of firms across the globe. First, there’s nothing revolutionary about “buy low, sell high,”. But many investors who were eager to buy in as the market peaked are now fretting about exiting. These age-old ideas continue to benefit principled investors as long as human nature leads to panic selling in times of crisis.
Speaking of crises, the focus on past economic earthquakes like the Great Depression, 70’s stagflation (and OPEC price increases), the Dot Com Bubble, and the 2008 financial crisis and Great Recession provides another reason for calm: no matter how deep the economic hit, markets have always found a way to bounce back and provide returns for investors who remained in the market.
The novelty of the current crisis can make it feel like nothing is certain, but past crises were new and unique too. Historical evidence suggests that companies will re-tool and re-orient to succeed in the post-COVID economy.
The fact is, no one understands the full long-term economic and financial implications of the crisis. But focusing on efficient market pricing is a helpful conceptual anchor: we don’t want to assume that each round of bad economic news will cause further financial damage – much of this damage is already included in asset prices. Meanwhile, balance sheets remain strong, additional fiscal stimulus is on the way, and the economy should be well-positioned to weather the storm and eventually bounce back as it has in the past.
We hope these notes have provided some helpful insight as you work to plan for your financial future in the face of current events. If you would like to discuss what you can do to shore up your financial
plans when facing an economic crisis, reach out to our advisory team.