On Wednesday of last week (Feb. 19, 2020) the S&P 500 reached an all-time high of 3386. Today as I type (1pm on Friday, Feb. 28, 2020), the S&P is trading at 2932, down 13.5% in just seven days of trading. All three major US indices (Dow, S&P, Nasdaq) are in correction, defined as a decline of at least 10% from a recent high.
The selling has been driven by the uncertainty created by the spread of the coronavirus COVID-19, first detected in Wuhan City, Hubei Province, China—the seventh-largest city in China with 11 million residents. According to the interactive web-based dashboard developed and maintained by the Center for Systems Science and Engineering (CSSE) at Johns Hopkins University, as of February 28, there have been 83,867 confirmed cases and 2,867 deaths resulting from the virus. Also according to the website, more than 36,686 people have recovered from the virus thus far. 78,824 of the total cases have been in mainland China while 5,043 have been outside of China, including 60 confirmed cases in the US (0 deaths, 6 recoveries).
The stock market does not like uncertainty. The price of a stock today reflects the present value of all future expected cash flows. Investors price a stock as a potential buyer of a company would. “What am I willing to pay today for a specified stream of future earnings?” The more certain the stream of future earnings, the more confident an investor can be in paying a certain price. When the timing or the amount of the future stream of earnings is unknown or uncertain, the investor has less confidence and is not willing to buy or to pay as high of a price. The coronavirus has introduced significant uncertainty regarding future earnings and stock prices have fallen. Prices may fall further. We should tell ourselves that they will.
Because this virus is spreading around the world, we will continue to hear about it at a minimum, and we may have to deal with it personally if cases are confirmed locally. The virus—and the effort to prevent it from spreading—is disruptive to business and every other aspect of society. If the virus spreads in the US, we will have to deal with the disruption. Schools and businesses might close and our healthcare leaders might restrict our movement. We should prepare for the coronavirus to be a part of our lives at some level for weeks and perhaps months.
Even as plummeting prices and alarming media coverage make this a difficult period for investors, we think it makes sense to stick with your long term investment plan. Ideally your portfolio allocation is appropriate, reflecting your need for liquidity and your comfort level with volatility. Of those two, liquidity is the biggest driver. Having enough liquidity (bonds/cash or income from employment or other sources) provides staying power and eliminates the need to sell into a falling market.
Below are three of the key tenets of our portfolio management philosophy at Bragg. These tenets lead us to invest in stocks for the long term. They also lead us to advise our clients to stick with a long term investment plan.
Stock ownership creates wealth over the long term. A share of stock is much more than a piece of paper; it represents true ownership in a business. In its simplest terms, investing in stock over the long term is an investment in people…a belief that given an opportunity and an incentive, people will make progress. Owning stock allows us to share in this phenomenon. Over time, the returns our clients expect from their portfolios will be generated by our investment in stocks. The fixed income (bond) component of the portfolio exists to create liquidity, cash flow and a much-needed buffer when stocks are volatile. While fixed income is a necessary portfolio component for most of our clients, we don’t own it for growth; the growth will come from the stock ownership.
Humility is our greatest strength. We acknowledge that we can’t see the future and we distance ourselves from people who claim to be able to do so. Humility is a critical component of our success, underlying many of the decisions we make as we manage portfolios. It results in our having a healthy respect for the market. The market is efficient; it is hard to beat the market and even harder to time the market. We won’t trade frequently, we won’t load the portfolio with a handful of our “best ideas” and we won’t rotate among sectors or asset classes.
Discipline wins, emotion loses. The client’s investment plan is informed by the client’s financial plan. Portfolio holdings reflect the client’s need/desire for return, comfort level with risk and importantly, the need for liquidity. Investing in stocks can be risky; volatility and significant market declines are expected from time to time and history has demonstrated that many investors make costly, emotional decisions when markets decline. We make a significant effort on the front end to be sure the client owns a portfolio that is appropriate. We then manage the portfolio with great discipline and leave emotion out of the process.
At Bragg Financial we are not virologists, but we think the US economy and stock market will move past the coronavirus crisis for the following reasons:
The history of epidemics, pandemics and other outbreaks like SARS (2002-2004), H1N1 Influenza Virus (2009 Swine Flu), MERS (2012) the Zika virus (2015-2016), Ebola (2013-2016, 2018) demonstrates that while these threats are real, coordinated efforts by scientists, healthcare professionals and other leaders have gotten us past them.
The mortality rate of this virus (apparently 2.5% on average), while significantly higher than the influenza virus (approximately 0.1%), is lower than some of the more deadly viruses such as SARS (9.6%), MERS (35%) and Ebola (50%).
And finally, we put a lot of faith in the human ability and determination to just figure it out and move forward. People want to be well. They want to go back to work. They need to go back to work…yes, the financial incentive is a tremendous driver here. Simply put, humans will progress.
We hope this is helpful. Please let us know if you would like to discuss your portfolio or your planning. Thank you for trusting Bragg.
Correction: An earlier version of this article listed the mortality rate of the influenza virus as .001%. The correct mortality rate of the influenza virus is 0.1%. We apologize for the error.
Benton S. Bragg, CFA, CFP®
President, Bragg Financial Advisors