Portfolios and Pandemics
They say March goes in like a lion and out like a lamb. The last week of February was not meek nor fierce, but ugly, and I don’t know what to call it. February begins with hearts and flowers, and ends with a new virus, entire cities under quarantine, and all the stock traders heading to Harry’s Bar?
What am I saying? Traders always head to Harry’s after the bell rings.
Levity aside, the Coronavirus (aka COVID-19) that began in China late last year was beginning to spread in earnest to other countries last month, potentially shifting from an epidemic (an unexpected increase in disease) to a pandemic (the disease spreading to several countries or continents). Then last week, clusters of people in Italy and Iran were found to be affected, and the first incidences of community transmission (contracting the virus not through travel or from contact with an infected person) appeared in states along the U.S. West Coast. The news that the virus wasn’t going to be contained as hoped finally set off financial markets, and in five days U.S. stocks lost their gains since the beginning of the year.
To be clear, that is eight weeks of stock market gains lost. Not the last decade of growth or half your portfolio. The noise in the media – “the Dow’s biggest one-day point drop in history” – “stocks’ worst week since the Financial Crisis” – hasn’t helped put market fluctuations in perspective. If the stock market scale is the highest it’s ever been (i.e. Dow 28,402) and there’s a 10% correction (there have been 26 since World War II), the same 10% correction compared with other years would be the “biggest point drop in history.” (10% x more points = bigger point drop.)
Where is Andrew Yang and #Math when we need him?
This is not to say that reports of the market losing hundreds of points in a short period isn’t scary, in addition to the rising tally of deaths from the virus and uncertainty about its transmission.
The Stock Market is Not the Economy
Stock market prices operate a lot like pixie dust. Like the pixie dust that let Wendy and the Lost Boys fly if they believed they could, a stock price can rise because people believe something about it as well, and it may not be anything more substantial than fairy dust. Just ask anyone who was waiting for the WeWork IPO.
Stock market prices start with fundamentals: public companies report sales, cash flow and profits, pay dividends, invest in their businesses and take on debt. These factors make up a company’s economic footprint in the overall economy. In general, that footprint doesn’t change, even as an industry might fall into or out of favor with investors. Investors’ feelings about the stock and its potential, or feelings about interest rates, inflation and the general economy can also drive stock prices up or down. So because we believe stock prices should be high, they are. And similarly, if we stop believing, we are flying high no more.
No question, COVID-19 has disrupted the global economy in a fundamental way. Companies here rely on companies there, and when they get quarantined, our economy gets locked down, too. Federal Reserve Chair Jay Powell offered this measured statement, “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity.” That’s it in a nutshell. What the Fed could do is cut interest rates, but while that might make Wall Street happy for two minutes, it won’t do much to alleviate issues with global supply chains. This next week will likely be another roller coaster, with the February Jobs Report due out (like to show solid growth), SuperTuesday, and more information on COVID-19 as events unfold.
The Economy is a Tough Cookie
Luckily, the economy is not the stock market. In addition to public companies, there are tons of small businesses, government enterprises, and not-for-profit organizations – hospitals, schools, your local cafe, your dentist and your tax preparer for example – not as connected to the global supply chain and financial markets, and most of economic life continues even if the stock market tanks.
But how the two are connected brings us to the Coronavirus. The virus started in central China in the city of Wuhan. When Wuhan was locked down in an attempt to contain the spread of the disease, 11 million people were under quarantine and one of the world’s largest cities and its economy jolted to a stop. One link in the supply chain of a number of major industries created a block in the road these supplies travel, a road that now stretches around the world.
That was in late January. As the impact of the virus emerged, we learned more about its virulence, too. We took measures to control the reach of the virus beyond its epicenter. As a smattering of cases showed up outside China, the news had little impact. But pockets of a significant number of people were affected elsewhere, and we discovered there may be a more mysterious means of disease transmission, we started to feel less on top of this.
How the Cookie Crumbles (or Doesn’t)
The pixie dust disappears. Supply chains get disrupted, and companies don’t have inputs to do what they need to do. We start to think about what it would mean to be under quarantine here. Then in other places, outside of our region. Seattlites had a taste of this last winter, during Snowpocalypse, when the greater Puget Sound region was socked in by a freakishly large snowstorm. We learned we could shelter in place, work from home, and lay in supplies for a couple of weeks. But we also knew the snow wasn’t fatal and we had a rough idea how long it would last.
There are NO indications that COVID-19 is going to threaten all life on the planet. It does appear the virus is 20 times worse than the flu, which kills thousands of people annually, but most who contract the Coronavirus are expected to recover fully. People will recover, they will go back to their jobs, factories will resume work, and economies will ramp back up.
What Recovery After a Pandemic Might Look Like
There has been a lot of comparison between what happened to the stock market and the economy during past worldwide health crises. In the cases of recent events like SARS and MERS, we rebounded relatively quickly. But the state of the economy around the time of each of these crises, 2003 (SARS) and 2015 (MERS), was different than it is now. SARS followed the dotcom bust (2001-2002) and MERS followed the Financial Crisis (2007-2009). Each pandemic hit as the economy was beginning its rebound after a significant downturn, and the momentum of that upswing likely helped the overall recovery.
In 2020, COVID-19 comes as the U.S. economy has been on an upward trajectory since the Financial Crisis, and after this recovery was extended by tax and policy manipulation from the Tax Cuts and Jobs Act in 2018 and three interest rate cuts in 2019. The big tax cut of TCJA went to large corporations, which promptly used those funds not to give bonuses and incentives to workers, but to buying back shares of their own stock, increasing their stock price. Interest rates are typically cut to stimulate the economy, which if you believe the President, has been “tremendous” under his administration, yet we had three last year and there is lobbying for a cut now.
The economic recovery from COVID-19 will likely be much more shallow than those we saw after SARS and MERS. There are few tricks left to prop up stock prices, even after the virus is contained. Growth relies on innovation and demand, so great new ideas, and increased demand will drive an economy forward. There will likely be some pop in demand in this recovery, as pent-up consumption is met, but this bump in growth should be factored into stock prices. Some industries will write-off a season: fisheries, some agriculture and other perishable commodities that experienced a drop in demand and/or a lock-out to customers due to quarantines and travel restrictions. With an election coming up here in the U.S., there could be other domestic uncertainty to create skittishness in markets.
Getting to a recovery inflection point might take longer, too. The U.S. is one of only two developed nations without guaranteed paid sick leave. According to the Department of Labor, more than 1 in 4 workers in the private sector don’t have paid sick leave. This group includes more than half in the bottom 25% of the wage distribution, meaning those living paycheck to paycheck. What do you do when you *might* be sick, but staying home and not going to work means skipping groceries, heat or rent?
This crisis reveals risks we knowingly accept in our economy, to its health, and to ours. Colleague and physician/advisor Carolyn McClanahan notes the need for our politicians to put better protections in place, both for public health and for economic resiliency. “Our public health system has been starved for funding by both parties for decades. Public health is not a high-cost service to begin with, and the economic security a well-funded public health system provides greatly outweighs the cost.” This is not a partisan issue, it is necessary attention to protecting what we all have in terms of health, and wealth.
In the long run, the U.S. economy will bounce back from the impact of the Coronavirus. There is nothing the CDC or NIH have said that would lead us to think otherwise. That said, it becomes more difficult to see what drivers of economic growth will continue to build on a stock market still at very high levels, even after the events of this past week.
WHAT YOU CAN DO:
• If you’re still working, you are likely saving, probably into something like a 401k or 403b. Unless you started your contributions to Cash thinking you’ll figure it out later (note to self: get on that!), you’re dollar cash averaging into any stock allocation you have in your account. As the overall stock market falls, you’re buying more shares with your contribution. Provided your allocation is appropriate, keep on keeping on.
• If you haven’t found a way to telecommute, now would be a good time to figure that out. A quarantine would be hardest on the self-employed in customer-facing jobs where employee benefits like sick leave aren’t typical: your hairdresser, chiropractor, or local mom-and-pop grocer. Emergency reserves are even more important for these folks.
• If you’re retired or nearly there, you should have started to carve out less volatile, non-stock portions of your accounts that are invested in totally boring bonds and maybe a stable value fund. (If you are a client, we have done this.). You might be tempted to keep everything you have in stocks when stocks are doing well, but setting aside the amount you need for the next year or two of your expenses in Cash, and the next two or three years of expenses after that in CDs or bonds, for example, gives you a multiple-year buffer to let the stock-based growth engine in your portfolio recover from any bumps.
• If you haven’t looked at the asset allocation in your portfolio across ALL accounts, do it. It might be harder to look now, but not having a handle on your finances will not help you manage them. You can start by looking at the asset allocation pie charts that come with your retirement accounts; if they all say “98% stocks” then you have a good idea of your exposure to a decline in the stock market.
• If your asset allocation is only stocks and cash, your portfolio is NOT diversified. Bonds, CDs, REITs, and other types of assets in the allocation spectrum give you a diversified portfolio. There’s never a “best” time to rebalance, but now is a good time to consider how much exposure you want to have to the stock market; shifts in your retirement account holdings come with no tax cost.
• If you don’t have or recently tapped into your Emergency Fund, do what you can to build it back up. (One upside of a quarantine may be staying in, and spending less; you know where I’d recommend those extra dollars go.) Cash reserves are completely boring and unsatisfying — until you need them. Target six months of your “absolutes” – the expenses that must be paid; twelve months if you are self-employed.
• Contact your representatives about concerns about health care protections. Capitalism isn’t going to solve COVID-19, but adequately funding the governmental entities charged with keeping us safe from health threats from COVID-19 to the flu might, and establishing universal health care and paid sick leave would go a long way to protecting what is now our economy’s major asset: people. Healthy ones.
• Wash your hands. One of the biggest assets you have to protect is your health, and washing your hands thoroughly and often is one of the best protections you have according to the experts. Like your finances, a good solution doesn’t have to be complicated. Protecting your health also protects the health of those around you.
Tuning out the hype on both sides could be one of the best things to do. Now is a good time to focus on what YOU need in terms of your portfolio, and to take steps to make sure it’s supporting those needs. It’s also a good time to consider how we are more connected than ever, as players in a global economy, regardless of whether we ever leave our home town, and in terms of public health and taking care of each other.
I closed out this February watching Saturday Night Live, with Larry David reprising his role as Bernie Sanders. In interrupting a press conference on Coronavirus, “Bernie” notes: “Universal health care doesn’t sound that crazy now, does it?”