A number of readers have reached out to me with respect to how I am investing during the Covid Recession. Several have even asked me when I think the stock market will recover. Well, I figured now might be a good time to explore how I am investing during this uncertain time.
Privilege Allows Me to Continue Investing During the Covid Recession
As I’ve noted before, I’m one of the lucky people who has not lost his job and is fairly well insulated from what is happening financially in this country. Financial crisis and recessions represent great opportunities for the cautious investor. But as I noted before, if you are someone in the position to get ahead from this crisis, please don’t forget to help your community and charities during this time of great need. While I will progress from here on the opportunities, I ask that the reader where possible combine their pursuit of personal gain with aid to their community. With that said let us begin.
Investing and the Stock Market During the Recession/Crisis
If you have been paying attention to the stock market lately you are most likely greatly confused. The market reached an initial bottom on March 23. Since then many stock market indices like the S&P 500 are up more than 20%! Conversely, the news around the economy has been nothing but bad. The death toll and cases of the virus have risen massively. Unemployment is growing at a rate never seen before, now over 22 million. So how can we square the movement of the economy with the movement of the market?
The Economy and the Stock Market Measure Different Things
Well frankly, why are you trying to square them in the first place? The first thing to be aware of is the economy measures something different than the market. The market measures forward earnings, that is the profit expected going forward from the underlying company’s. It does so in the context of years in the future. The economy meanwhile is measure in a here and now approach.
So the first question is do you think the current viral crisis will affect company profits 5, 10, or even 15 years in the future? The answer to that question is murky at worst, but unlikely is the highest probable answer. So in some respect, there is an argument that stocks and the economy (especially unemployment) are not measuring the same thing.
The market history reflects this. There are a significant number of stock market ups and downs that have no correlation to the economy. In 2018 we experienced a near bear market correction, was there a decline in the economy? No! The 1987 stock market crash, again nothing to the economy. Obviously the market has a long history of behaving in a manner disconnected from the economy. Why would we think now is different?
Expectations Versus Actuality
Furthermore, the market reflects pricing based on investor’s expectations of future profits. So not only is the question about what this means for the future important, but also the question is what do investors think it means. The economy is a measure of what actually is happening. That may be completely different than what people expect.
Your Guess is as Good as Anyone’s as to What the Market Does Next
It would be foolish for one to conclude that our current economic crisis won’t impact the market. After all the market dropped precipitously initially. But it’s also foolish to guess what the market will do next.
The Dead Cat Bounce While Investing During a Recession
Take the 2008 crash. If you look at the data the market initially dropped like this one. But suddenly it recovered, rather dramatically. That lasted a short time and then it dropped again. That is what is called a dead cat bounce. The idea that the market has a quick sizable recovery after a massive decline. Then the market continues it’s decline.
This sudden significant stock price increase is theorized to be caused by people who hold stocks short being squeezed. When you short a stock you need to buy shares to cover the value of the short, sort of as collateral. As a stock prices increase you will eventually be required to buy more of these stocks as collateral. A short squeeze is when the price begins to move up, which triggers the gathering of collateral by those shorting the stock. That gathering of collateral then drives the stock even higher as the shorts buy more coverage. Stock trading volume, which is usually reduced during a crisis, exacerbates this movement. It makes it likely for a dead cat bounce to occur.
Is this a Dead Cat Bounce?
Does that mean this is a dead cat bounce? Well maybe not. The great recession also informs here. The recovery of the market in 2009 began while bad economic news was still occurring. If you had waited until the all-clear on the economy, you would have missed one of the biggest increases in the market in the last 20 years. That isn’t unique to 2008 either. Market traders even have a saying, be cautious when others are greedy and greedy when others are cautious. IE buying when people are still fearful is the best time to make money.
So how do you tell which one this is? Well, you can’t. Only in hindsight can we tell if this recovery is real or just a bounce before another long leg down. This is why I am against market timing, because there is no reliable way to be sure what happens next.
My Own Investing During the Covid-19 Crisis
Without reliable direction on what comes next, I am continuing to do what I always do. I am following my Investment Policy Statement (IPS), which explicitly states to continue to purchase stocks at my normal rate. It does state to rebalance if I fall 10% outside my asset allocation band. But otherwise, my actions are to just stand here and do nothing. Our asset allocation was slightly stock heavy before the decline due to recent run-ups in the market. I also rebalance slowly using new money. As such at least to date I’ve had no need to rebalance.
I Moved My Safer Portfolio Around
My only move to date on market-based securities was to sell a position in a corporate bond ETF. I moved this investment to a TIPS based fund. I favor bonds as a lower risk volatility dampening investment. Companies are rated in a corporate bond ETF by their creditworthiness. The fund I used focused on highly creditworthy companies. Ie companies with the finances representing a low likelihood to go bust
The problem, with the sudden lockdown I no longer trust the ratings. A restaurant or travel company might have excellent credit. But if you shut down their industry for months at a time and the credit market collapses that rating may be worth nothing. Frankly, the market shutdown is effecting companies in an unanticipated and unprecedented manner. Given my stated goal to use bonds to reduce volatility, and the added risk of the corporate fund not meeting that need, I chose to move to less risky government and inflation-protected bonds. This represents a very small portion of our portfolio, nearly a rounding error regardless.
The Opportunities Investing During the Covid Recession
So if you are reading this far you might be wondering, where is the opportunity? If you are staying the course how are you going to get a leg up during this crisis? Well, the answer is two-fold.
First, changing nothing means you profit in the long run. If you continue to buy good or bad, then you will be better off then if you bought everything before this started. You are buying stocks on sale at some point, you are just doing so automatically without the need to know when they bottom out. What you give up in profit you benefit from not having to be right on when.
Timing Marketable Securities is a Fool’s Errand
Second, marketable securities are just one part of market opportunity. Market securities are highly liquid. They respond to changes in the macroeconomic environment and people’s sentiment quickly. They also are more likely to price the expectation of the populace in. Why? Because the number of people buying and selling marketable securities like stocks and bonds daily drives the price to near the aggregate of everyone’s expectations of value. But if you step outside marketable securities you are more likely to find opportunities for investing during the Covid-19 recession.
Illiquid Investments Can Present Investing Timing Opportunities
Picture things this way. You are on the search for a rental property. A rental property probably has a handful of bidders in most periods. A stock has potentially thousands. It is thus more likely that rental property, which is then priced based on the aggregate of the bidders, will differ in price from the aggregate of society by a wider margin than the stock.
In times of economic hardship, the number of bidders in illiquid markets decline. People who fear the uncertainty of whether they can pay for things in the future don’t lock up their money for years. The market bidders decline but not nearly as significantly. As such the non-marketable securities become even more priced for opportunities.
An Increase in Supply of Illiquid Securities For Sale Decreases their Price
This is potentially further escalated by an increase in supply of these illiquid investments. As people tend to have money problems paying mortgages and other loans, they sell their rental properties to stay afloat. The more for sale and the less buyers drives prices down based on supply and demand. This is all to say that the real actionable opportunities during a downturn exist in the illiquid investment market.
The Problem of Choosing the Right Illiquid Investment
Now not all of these illiquid investments will be equal. Will retail real estate recover, or will all the collapsing restaurants make them unviable? Will rental real estate sour due to the recent laws around not being able to evict non paying tenants during the crisis? It’s too early to tell, but at some point, it will become obvious which types of illiquid securities are dropping and why. It will also appear likely at some point that many opportunities will present themselves in some of these areas.
Few Will Have the Means to Benefit from Opportunities
But the number of people able to take advantage of those opportunities will be small. The reality is, what will drive these realities will be the decline in buyers. The decline of buyers will be driven by previous investors not having the funds to invest, loans potentially being harder to come buy, and even investor sentiment. Having money to jump on these opportunities will benefit you in the long run.
Preparing Now for an Investing Opportunities 3-6 Months in the Future
I’d guess we are 3-6 months from this being an opportunity that manifests itself. Why? Right now foreclosures for most people are also postponed due to the virus. But once that gets removed people that have lost other forms of income will likely be forced to move towards the exits. That’s when the opportunities for investing during the Covid-19 recession will present themselves.
Luxury Goods Will Eventually Also be On Sale
In addition to the above, luxury goods and other purchases will also potentially decline in price. We’ve been talking about a travel trailer for a while. It’s likely we will be one of the few people shopping for one of these in the next few years. So it is a good assumption that I will be able to pick one up cheaper in the next few years. At least cheaper than when everyone was buying during the up economy a few months ago. Again we are probably a few months out from these deals.
I Am Now Diverting Some Savings to Cash Like Holdings for Future Investing Opportunities
In light of the above, I am beginning to save some of our non-auto investing income in short term savings accounts and CDs. This may seem similar to the dry powder concept I made a stance against. In this case, the main difference is I have no intention to use this money for market securities in the future. I am really against market timing, not saving money for specific opportunities.
This is more akin to steps you would take when saving to buy your first home. In this case, we have a potential series of large purchases in the near term (6 months to a year horizon) which need to be set aside in low-risk vehicles. Holding any type of near time funding in a market (regardless of volatility) is a bad choice. The stock and bond markets are vehicles for long term investing only. Cash and Short Term CD’s are the right investments to prepare for this type of opportunity.
Expect Future Updates On Our Actions Investing During the Covid Recession
Anyway, as we get closer into the opportunities we will write more about how we are executing on these funds. Stay tuned.
How are you investing during the Covid-19 recession?