Just like life, stock markets aren’t sunshine and rainbows all the time. Sometimes we face dark clouds and sometimes it rains. Sometimes when it rains, it pours. However, just like some rain comes with the promise of a rainbow in the end, tumultuous markets too come with the promise of large profits as the same businesses are now available for cheaper prices, and therefore offer the potential for higher return. Just as a healthy life anchored on high values can weather any storm, a few basic investing principles have stood the test of time again and again. At the risk of sounding like a broken record, we want to highlight a few of them below.
A well diversified portfolio reduces investment risk
Invest according to your risk tolerance
Time in the market is more important than timing the market
Keep a long-term horizon for compounding to work in your favor
Rebalance your portfolio when the asset allocation deviates from original intention due to market fluctuations
We have no doubt that these principles will stand the test of time again as the world economy came to a grinding halt within a matter of weeks and precipitated a market sell off. The COVID-19 pandemic rages across the globe with scary headlines and statistics (and rumours) capturing most of the print and airwaves. Global stock markets are now in the bear market territory (defined as > 20% decline from peak to trough) and the world economy is most likely in a recession as businesses are forced to shut to contain the spread of the virus.
Amid the fear, it is easy to lose sight of the fact that the same businesses were flourishing a month ago with investors willing to pay much more for the same stock than what they are available for now. Taking a step back helps one realize that the pandemic might disrupt these businesses for a few months, but if they have a strong balance sheet, they will weather this storm and continue to do business for many more years. Do a few months of lost business justify a value erosion equivalent to about one-third of the expected value generation during its entire life? The answer to this question is obvious; what does require some effort is finding a quality business with a strong balance sheet. We at O’Farrell Financial have a team of experts that specialize in directly finding such businesses and/or identify portfolio managers that can find quality in company financials.
As observed in the countries that have successfully flattened the curve, we think that measures such as strict adherence to social distancing and forced lockdowns could see the mayhem begin to peak in about a month. This would be followed by another month of cautionary shutdowns before returning to normal. As an average bear market has already run its course (~35% average decline) we think the upside potential outweighs the downside risks from current levels. We do know that quality businesses are now available for sale and portfolio actions like rebalancing or deploying fresh capital to dollar cost average would allow for a greater participation in the recovery phase. We think the initial recovery is likely to be swift so major changes or moving portfolios to cash could prove to be a costly mistake. Given our expectations of beginning to return to normalcy in a few months, we estimate ~20-30% upside in the stock markets from current levels until end of the year 2020 and a full recovery by the end of next year.
Meanwhile, stay safe and know that this too shall pass. Contingent to your risk tolerance, comfort with volatility, and stage of life, O’Farrell Financial has chalked out an optimal strategy for your goals and our advisors are here to help you navigate through the ups and downs of the stock market by answering your questions and helping you stay on track with your financial plan.