We have talked about this day for over a decade. We have always said, when the next crisis hits, we have a plan and we will execute the plan. We also said we would respond by explaining what has happened, what we are doing about it, and finally what we expect going forward.
Well, this is that moment. In this report, I will address each of these questions as it relates to our managed account portfolios. Please take the time to read this over. I am writing because it is the quickest way for me to get to everyone, and it allows you to consume this information on your own timetable.
So, let’s get right into it.
Here’s What Has Happened:
Coming into 2020, we saw continued opportunity for economic prosperity here in the United States. Without the onset of the coronavirus pandemic, I felt we would be setting new all-time highs. That thought is just a memory now after 15 days of rapid market declines.
Plain and simple we are seeing fear and panic levels that we have not seen in over a decade. We are seeing 1987 and 2008-2009 levels of fear as expressed through volatility within the markets.
As of the time I am writing this, the stock market has moved lower in 13 of the last 15 trading days!
Predicting and adjusting to a market in rapid decline is a challenge for all investors. With this said, we have a plan of action and we are executing the plan. We appreciate everyone’s patience as we work to navigate the everchanging conditions we are facing.
Here’s What We Are Doing:
The facts of the market have changed, and the bears are firmly in control of this market environment. As a result, we have adjusted our approach to adapt to bear market rules.
One of the time-tested tools we use to help preserve capital during an environment like this is called a trailing stop-loss.
For those who do not remember how stop-losses work, it serves as our last line of defense from falling stock prices. A trailing stop-loss is a protective level that we establish beneath each of our holdings within our managed account platform. When the price of a stock drops below our predetermined level we sell. No questions asked.
Think of it as a proverbial “line in the sand”. If the price drops below the protective level, we sell.
Here is a chart showing Sysco Foods (SYY), a company we first started buying in August 2011. The blue line is the price of the stock over time, and the orange/brown colored line is our trailing stop-loss. Notice how the stop-loss line only moves higher. Each day the stock price rises, so does the stop-loss. If the price falls, the stop-loss line holds steady.
Here’s the chart:
SYY is a great example of using a stop-loss to lock in long-term capital gains. Not all positions have been so fortunate. Others have resulted in net-losses, but we use stop-losses to keep our losses from turning into bigger losses.
Now that the bears are in control of the market, we have to give them the benefit of the doubt.
As they say in the science world, when you have too many unknown variables you cannot solve the problem. This is what we are facing regarding the coronavirus. I am not going to give any specific opinions about the virus other than to say be cautious and protect yourself as you see fit.
So, what does this mean for our investments going forward?
Here’s What I Expect To See Going Forward:
In time, I believe this virus will run its course and globally we will look to resume our normal day-to-day activities. The big question is just how far and wide the virus will impact us here in the US. Right now, we are dealing with the fear, but soon we may deal with the panic.
I separate the two because investors are currently fearful of “what might be”. In the days ahead we will face the (potential) panic because of what is happening. In a few days/weeks I believe we will see a significant climb in the rate of coronavirus cases here in the US. This rapid rise will occur if for no other reason than more of the test kits getting out into the medical field and more people getting tested.
IF (and it is a big if) we were simply looking at economics and historical financial data, I would want to be a buyer at these levels.
Based on long-term history going back decades, when the Volatility Index (VIX) which we use as a measure of fear, hits levels like we are seeing now. It typically marks significant lows in the stock market. As a result, the history of the VIX would say it is likely to be a good time to be putting money to work in the stock market. Of course, it might be different this time.
Here is a chart that illustrates my point:
The squiggly black line is the VIX and each time it has moved higher than 35 (blue horizontal line), historically it would have been a good time to be a buyer of stocks for long-term investors.
With this being said, no one can say for sure what will happen this time. My advice is to stay patient and don’t be in a rush!
An Important History Lesson
Let me share my perspective on why I believe trailing stop-losses are paramount to being a successful long-term investor and I doubt I will ever invest without them.
Back in March 2000, the NASDAQ reached its peak at more than 5,000. It then dropped over the next two and a half years before hitting bottom at 1,114!
That is a massive move to the downside. It’s one some of you still remember well. I certainly do.
Here is the reason stop-losses are so important.
Investors who kept saying “It will come back soon” kept buying. They bought more at 4000, 3000, 2000, etc.
They bought all the way down and it wiped out a massive amount of their net worth.
To be clear, I am NOT predicting this is the kind of move we are facing today, but I want you to understand why I so often preach the merits of trailing stop-losses and why I follow them religiously even when it does not feel good to sell long-term winners.
If more investors would have followed a trailing stop-loss protocol during the tech market bust, they could have protected themselves from catastrophic portfolio losses.
Our goal of using trailing stop-losses is not to prevent all losses with a portfolio. It is impossible to prevent all losses.
We are trying to prevent catastrophic losses and limit our downside risk. It is also a way to logically counter our human tendency to overthink and outguess where the market will go next.
Don’t guess. Let the market be our guide. Currently, the bears are in control and as a result, we must invest accordingly.
This means religiously following our stop-losses, it means not being eager to buy, and it means staying calm even when stress levels are at a high.
Closing Thoughts
There is no way to know how far this bear market will go. History, using the VIX (chart shown above), says conditions are right to begin the process of establishing a bottom, but nobody knows for sure where the ultimate bottom will be.
In recent days, I have been getting one of two main questions:
- Is it time to Buy?
- Is It Time to Sell?
I am a data-driven investor. I like to use history as a guide and history would suggest there may be an amazing buying opportunity ahead.
I cannot say if it will be days, weeks or months before this opportunity presents itself, but when (or if) it does, we will need to see it in the data before taking action. We do not want to guess.
Thankfully we have a process for getting back into the market as conditions warrant. As I always say, when the market facts change, so shall we.
My friends, the facts of the market have changed. The bears are in control of this market and we must play the game by their rules.
I will continue to monitor all positions and make portfolio adjustments as warranted by changing market conditions.
Please be safe and take any and all provisions to protect yourself and your family during this time of uncertainty.
Kern
