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WJ Conference Call Recap

Posted: Jared Jameson

Last week, we hosted a conference call with our clients to discuss the recent market environment, how we have  been positioned, and opportunities we see going forward. In addition, we received several important questions that we think are representative of what other investors are thinking. This WJ Notes will serve as a recap of the call and those questions and answers.

“There are decades where nothing happens, and there are weeks where decades happen”

This quote perfectly sums up investing. In most years, the stock market does fine, and bond markets behave as expected. However, in just ONE MONTH, the Dow fell over 37% from its all-time high in February, erasing all the gains it had made in the last 5 years. High-yield bonds on Monday were trading at levels not seen since May of 2013.

Liquidity quickly dried up in the market as there was a rush to sell into cash. Investing relationships that usually hold up were breaking down. Typical safe-haven assets like gold and treasuries were selling off along with stocks. Oil prices (WTI) have not been this low since 2001, and in fact we had higher prices as far back as the 1980s.

Prior to the selloff, we had been wary of the high valuations in the market. Markets (particularly US markets) were priced for perfection, and as valuations rise, future expected returns get lower. Of course, we never expected a pandemic to be the trigger to cause the markets to fall, but you never know what the catalyst is going to be. Typically, the catalyst is something no one is planning for, and that was certainly the case this time.

As a result of those higher valuations, as well as historically low yields in bonds, we have been positioned conservatively relative to our benchmark, and have been emphasizing diversification. This positioning has significantly protected our investors during this panic and will continue to do so.

Some examples of how we were positioned prior to the crash include:

  • No corporate credit held in the bond portfolio. (more on this later)
  • Underweight stocks and bonds in favor of alternatives, including managed futures and reinsurance, which have made money during the selloff.
  • Held a strategic position in a cash-like fund, awaiting better opportunities to reinvest.
  • Held a strategic position in longer term treasuries, as treasuries tend to do well in a selloff as investors look for safety.


Looking Forward

As unappealing as it might be, it is in moments of crisis like this one that we start to find opportunities. We are not trying to time a bottom in markets, and do no pretend that we can accurately forecast when the pain will be over. However, the prices we are seeing in certain markets have not been seen for years. Just like when you go shopping at your favorite store, you should be excited when things go on sale. It is only in financial markets that people run away as the sales get better and better.

We have already started and will continue rebalancing in the next several weeks. Rebalancing is simply buying the assets that have lost the most value, by selling the assets that have gained the most in order to get back to our target weightings. More specifically in our case, we are going to be selling small portions of alternatives and cash and buying back stock. We are not going to fully rebalance all at once, as this is akin to market timing, but will do so gradually.

In addition, we are going to start buying some corporate bonds in the bond portfolio for the first time in years. Corporate bond’s attractiveness is primarily measured by what are called credit spreads. Credit spreads are simply the difference (the spread) of what a corporate bond yields over a treasury bond. For example, in February just before the selloff, the spread for an investment grade bond (good credit) was about 1%. So, if a treasury bond was yielding 1%, you’d expect these bonds to yield 2%.

Over the last month, investment grade spreads went from 1% to nearly 4%! We have only seen these types of spreads in 2008. In addition, high yield bonds, which pay a higher yield because they are issued by riskier businesses, had a spread of about 3.2% a month ago. That spread got up to nearly 11% earlier this week!

This is not to say there is no longer any risk in these bonds. Spreads can continue to get larger, which will result in temporary negative performance. However, the risk/return tradeoff is now overwhelmingly in the investors favor.

That is a quick summary of what has happened, and what we are doing. Now let’s move on to some of our client’s questions from Wednesday’s call:

Question: Should we be investing in gold?
Answer: Gold is typically an asset held as insurance against extreme uncertainty, specifically a collapse in the dollar/high inflation. Proponents of gold point out that with the extreme actions the Fed and Treasury are taking to stimulate the economy with lots of new cash, the dollar should start to lose its value. This same argument was made in abundance after the Fed’s actions in 2008. It simply has not been the case, however. It has been a struggle just to get our inflation rate above the Fed’s target of 2%. As a result, gold’s price is currently about 15% lower than it was in 2008.

In addition, it is difficult to determine what the price of gold should be, as it produces no cash flow, and has no real utility. It is simply priced by supply and demand making it more of trading vehicle than an investment.

Question: I saw on the news that senators were warning others to sell because of what was to come in the stock market. Did WJ see it?
Answer: What I believe you are describing was that several senators sold some stock in late January after several private briefings. This was done under very suspicious circumstances, likely using insider information. At least one of those senators in fact is being sued. Another said they didn’t know about it and it was their advisor that did it. Another said they got the idea from watching CNBC.

I have  heard of no professional asset manager that aggressively sold risky assets due to correctly forecasting the significance of the virus impact back in January. I would be skeptical of anyone who says they did.

Question: How long did it take for stock prices to recover from a) 1987 crash and b) 2008 crash?
Answer: In the 1987 crash, the market recovered in about a year. In the 2008 crash, stocks took over five years to recover. The recovery times were much shorter for a balanced portfolio because the losses were substantially less than an all stock portfolio.

Question: I have cash reserves that might last 18-20 months. Would it be a good idea to live off this cash to delay selling off my investments at current low prices?
Answer: It is fantastic that you have such a sizable emergency fund, and it is for times like these that we recommend our clients have one. We would certainly recommend you use those assets before being forced to sell your financial assets at low prices.

If you do need to access funds from your portfolio, please remember you own many types of investments besides stocks which have not declined in value and are available to be sold.

Question: How long would you predict dividends/interest to be near zero in a conservative portfolio?
Answer: Today, treasury bond yields are at historic lows at less than 1% for a 10-year treasury. However as discussed earlier, corporate bond yields are now at the highest levels since 2008. As for dividend paying stocks, some companies have cut or suspended their dividend until cash flow returns to normal. This will likely last 3-6 months. However, dividend yields are a function of price. As the price of a stock goes down, the yield actually goes up. So, we are seeing some of the highest yields in stocks that we’ve seen since 2008 as well.

Question: I always thought that bonds rise in a bear market, is that not true?
Answer: This is a common misconception about bonds. It is true that historically, treasury bonds have done well in a bear market. However, there are many other types of bonds. There are corporate bonds, mortgage backed bonds, municipal bonds, etc. All of these bonds have had mixed performance in different bear markets. Corporate bonds, in particular, usually perform poorly in bear markets, as investors are concerned with their ability to pay their debts. Unfortunately, these are the types of bonds that most investors/advisors own in order to enhance yield.

Question: Does the firm believe the market will return to Dow 30,000? If so, when?
Answer: Yes! We do believe the market will return back to where it was only a month ago. The “when” is much more difficult. You have to accurately forecast the depths of this current recession, how severe the virus spread continues to be, and how businesses and individuals are able to bounce back. Even if you think it would take 5 years just to get back to break even, however, you would still be locking in a gain of 8% per year from the low. So even in a relatively pessimistic scenario, long term investors should be willing to buy stocks.

Question: It seems that the stimulus is propping up an uncertain market. Is now a good time to start averaging into bonds and stocks, or is it too early?
Answer: The federal stimulus package of over $2 trillion, in conjunction with the Fed’s efforts to provide liquidity to markets have certainly helped to slow the panic.

As said in the answer above, it is impossible to predict exactly when the market is going to bottom. However, markets are more than 25% cheaper than they were a month ago, so averaging into them as you say makes sense for long-term investors. The same goes for different types of bonds as we mentioned earlier in this note. We are starting to average in now.

We are going to continue hosting these calls every 2 weeks as needed. We hope you will be able to join us and ask that you send us your questions in advance if possible. You will also be able to ask questions during the call using the chat feature on Zoom. Stay safe, and as always if you would like to discuss your financial plan with an advisor, please call.

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