A framework for managing emotions and portfolios during volatile times.
These are truly historic times. As the global community grapples with the pandemic beast known as COVID-19, grocery store shortages, and quarantines - the robust bull market that began in March of 2009 has transitioned into a bear market, as of March 2020¹.
As equity markets fall sharply, it’s time for all investors to review the fundamentals – it’s time to learn How to survive a bear attack. There are four guiding principles that can help you manage your way through the volatility. They are:
Rule 1 – Vanquish fear and panic
Rule 2 – Know your environment
Rule 3 – Take advantage of opportunities
Rule 4 – Don’t be afraid of strange noises in the night
Let’s take a deeper dive.
Rule 1 - Vanquish fear and panic
Panic can drive you to make bad choices. In this unique time where we are all dealing with a serious health crisis coupled with economic turbulence, investors are wise to avoid the urge to make rash decisions. In the fall of 2008, it was well documented that during the first dip down of the credit crisis panic set in. Investors made snap decisions, and began to sell. Go a bit further along the timeline and there was further selling during the next dip down in February and March of 2009.
According to data collected by US-based Investment Company Institute, which tracks flows into ETFs and Mutual Funds in that country, peak selling was done at the bottom of the market. If you follow the flows, investors didn’t come back into the market until the end of 2012.
“The peak to trough in the Bear Market of 2008/2009, the market was down 57 per cent,” says Philip Petursson, Chief Investment Strategist, Manulife Investments. “Investors locked in their losses somewhere within that 57 per cent drop, and then didn’t join the market again until 2012 when the market hit the prior high from March 2007 – investors were never going to regain those losses.”
Time and again, emotions get the better of investors – fear of missing out will prompt buying at the high point in the market, and fear of losses will prompt a selling spree when markets dip.
“No matter how many times you tell investors, it seems like the same scenario plays out, where investors panic and react,” says Kevin Headland, Senior Investment Strategist, Manulife Investment Management. “You can almost call the bottom when you see the mass exodus on the mutual fund side, both in Canada and the US.”
A key contributor to current economic volatility is exacerbated by passive index investing. ETFs are comprised of a collection of securities, so when an ETF is sold, investors are selling every security in that ETF.“Weare seeing five to six times the selling volume, and that selling pressure is contributing to the volatility,” says Petursson.
Another issue contributing to market volatility may be the DIY approach to investing.
“In any given moment, you can check the status of your accounts, make a trade, and you perhaps have this unsophisticated investor making decisions without leaning on financial advice of experts, and that just contributes to panic,” says Headland.
By focusing on the fundamentals, by not panic-selling, investors can maintain the right position to weather market volatility.
Rule 2 – Know your environment
As part of the Manulife investment strategy, three key pillars are considered. They are:
- The economic environment
The economic environment guides decision making in what you should be paying for stocks and what a company is likely to earn. Valuation examines the worth of stocks and bonds. … And a company’s earnings can tell you a lot about the strength of the stock you’re considering purchasing.
“This is where from the middle of 2019 up until the beginning of 2020, stocks appeared to be fully valued to over-valued depending on the market, but based on our measures, we saw weak earnings growth. High valuation during a period of weak earnings growth is a warning sign,”says Petursson.
Trying to predict market outcomes on an evolving situation such as the global COVID-19 health crisis remains challenging, however the situation will eventually be brought under control.
“There’s a very high probability that Canada is heading toward or already in a recession. Given the containment efforts across Europe and the United States, we’re going to probably see those economies in a recession as well. But this is the reality right now,” says Petursson.
“Looking back to the beginning of 2019, we were already trimming our equity weights – not because we were predicting a recession, but we could see the deteriorating fundamentals,” says Headland. “If the economy is getting weaker, not stronger, and valuation is going higher, not lower, the fundamentals guide you to make the right decision, take some profits, and shift to an underweight.”
Could he have predicted the current state of market volatility? Petursson says with all financial indicators looking strong – positive yield curve, low unemployment in the US, good consumption levels, positive housing figures – the only thing missing was factoring in the risk for a black swan event such as COVID-19. “Now that it’s here, the work begins to figure out the implications and economic impact of business shutdowns,” says Petursson.
Rule 3 – Take advantage of opportunities
During times of economic volatility, solid asset allocation is the key to protecting your portfolio on the downside, while being structured for compound growth over the long term. By sticking to investing fundamentals, and knowing the environment, assets can be adjusted to take advantage of opportunity.
“In this current market, we want to be thoughtful in our approach,” says Petursson. “That means rebalancing portfolios, taking advantage of dips, and shifting from fixed income into equities to take advantage of opportunities as they present themselves.”
Whether you are in a bull market or a bear market, having the proper balance within a portfolio is always an important fundamental, while maintaining focus on your investing goals for the long term,” says Headland.
Dividend growth is another area for consideration when looking to rebalance portfolios during economic volatility.
“A company that has a good dividend and has proven over time that they can continuously increase their dividend indicates a quality business with continuous cashflow, and a solid management team,” says Headland.
A growing dividend shows a quality business that over time can withstand economic bumps, while compounding growth over the long term.
“It may not be the hottest stock or the most interesting area to be invested in, but over time that dividend will help you on the up side while also acting as a source of income even if the stock price is falling in the short term,” says Headland.
Headland add that during an economic downturn, this is when active managers will identify those quality businesses that may have a dislocation of their true value. And managers who identify those companies and take advantage through this time of volatility really show their true worth.
Rule 4 –Don’t be afraid of strange noises in the night
If something truly intends you harm, it will stalk you silently. “While no one could have predicted that a black swan event would land in 2020 and put a halt to the bull market, what we can do is manage the risk based on fundamentals, make recommendations, and position portfolios to be able to manage a market downturn,” says Petursson.
“It’s not a matter of predicting, but rather it’s a matter of understanding the risks that exist,” says Headland. “We don’t know why, we don’t know how, we don’t know when, but we do know that it is (risk) is coming at some point.”
“Focus on your investing goals while being aware of the risks within your portfolio and manage them appropriately. Allocate assets properly while sticking to a disciplined investment approach is the key to moving through market volatility. An advisor can help you do this. They’re trained to manage risk and seek opportunities in both up and down markets.” - Philip Petursson, Chief Investment Strategist, Manulife Investment Management
“Stick with investing fundamentals. They will always steer your through bear markets as well as bull markets.” – Kevin Headland, Senior Investment Strategist, Manulife Investment Management
Source: Manulife Investments Management