Portfolio Positioning in Light of COVID-19

Volatility in financial markets continues as the economic impact of Coronavirus is assessed. Markets are forward looking, meaning they attempt, through the action of millions of participants, to predict the future. Most of the time they are very good at predicting what is to come, but when something new or novel occurs markets have difficulty incorporating its ultimate impact. This results in extreme volatility and can lead to panic. In this WJNotes we discuss recent performance and portfolio positioning. Performance data below is through Friday March 6, 2020. As we post this WJNotes, stock markets are down substantially this morning and bond markets are soaring.

Since we are wealth managers, we will not make any forecasts or predictions about how the Coronavirus situation plays out. Even the experts do not seem to know. It does seem the virus’ impact will be with us for a while and we might have to learn to live with it like the flu. As people and governments accept this reality, the economic impacts of Coronavirus will begin to dissipate, and volatility will abate.

What has happened so far this year? Before we review the numbers, we want to remind you that the stock market is not your portfolio. It is a component of your portfolio. And for most of our clients, it is not even a majority of their portfolio. And, as is the case in most stock market sell-offs, other types of investments have done much better than stocks. In conjunction with falling stock price, yields on bonds have plummeted. The ten-year treasury bond currently yields only 0.75%, an all-time low. Prices of bonds move inverse to yields; thus, bonds are up about 5% this year, offsetting some of the roughly 10% loss in stocks in most portfolios. In addition, other diversifying assets in portfolio like reinsurance and managed future are up slightly this year. Thus, our more conservative portfolios are about flat for the year and our more aggressive portfolios are down around 5%. These are relatively modest losses and to be expected on a regular basis. It is the case that the sell-off beginning two weeks ago was unprecedented in terms of the speed, but not in magnitude. Of course, we do not know if it is over and that certainly makes us all anxious.

What are we doing? As of now, we have not made any adjustments to portfolios. We have been positioned conservatively recently expecting lower returns on most investments; thus, we are somewhat insulated from market volatility. In most cases, short term losses in stocks increase future expected returns because markets overreact and fall more than is justified based on the actual economic impact of a recession, pandemic or other economic event. The overreaction creates a buying opportunity. Stocks would need to fall approximately another 10% to create this opportunity. We would fund stock purchases with alternatives. Also, we would sell bonds and buy stocks to rebalance portfolios back to target allocation levels.

At this point, the bond side of the portfolio is more of a concern than the stock side. Basically, at current yield levels, you will not make money after inflation on most bond investments for many years to come. Low yields along with a flat yield curve implies cash or at least near cash type investments will provide returns comparable to longer term bonds. Therefore, it makes little sense to own more risky, longer-term bonds, and we will focus the portfolio on simply holding shorter-term bonds or cash equivalents. In addition, many alternatives that we utilize will likely outperform bonds. Assuming interest rates remain at current levels or move lower, we will transition the bond portfolio to more alternatives and shorter-term bonds over the next month or so. These moves will also insulate bond portfolios from future higher rates.

As always, if you have questions about your portfolio, please contact us. Unfortunately, occasional market volatility is the price we pay to earn reasonable returns on stocks long-term. The antidote to stock market volatility is diversification which is providing protection exactly as expected in this sell-off.