2020-03-20 Bear Market Probabilities and Alternatives

I’ve had a few conversations recently that started with the question, “Is it time to buy the bottom?”.

This is the question that everyone wants to know, and unfortunately, I don’t know the answer to that question, nor does anyone else.  Of course, if we did know the answer to that question, it wouldn’t be the question that everyone wants to know the answer to!

Given the level of volatility and uncertainty today, one could easily make a case for two wildly different scenarios:

In Scenario 1, people take the threat seriously and self-quarantine, events are cancelled, tests and other medical supplies are plentiful, and hospitals are well-staffed and able to manage the patient load. The economic fall-out from COVID-19 is manageable, the economy recovers, and the bull-market is extended for another few years.  In a best case scenario, we’re near the bottom now and fully recover by year-end.

In Scenario 2, people don’t take the threat seriously and don’t self-quarantine. Hospitals are overwhelmed and unable to manage the patient load. The summer brings some reprieve from the virus, world economies stabilize and markets rebound. However, by Fall , the virus reemerges and economic activity is deeply impacted, pushing the world into a global recession, exposing the underlying weaknesses of an economic system that was already slowing down and had been propped up by easy money since the Great Recession.  In a worst case scenario, we’re in the early stages of a recession and a long way from the ultimate “bottom”.

My clients, their families, and their financial and emotional well-being is of the utmost importance to me. I take that responsibility very seriously, and I work closely with clients to ensure that not only are they financially successful, but they are emotionally stable in the process.  So, how do I manage portfolios given these two very different scenarios?  First, it’s important to remember that we’d already planned for this.  As clients know, I’d warned that a significant correction was likely coming soon.  The question wasn’t if, but when, and we worked hard to develop a plan and position portfolios that would weather the storm.  Furthermore, we’d already reduced portfolio risk and raised cash levels. As I noted over two weeks ago, “the events of the past few weeks have filtered through our process and resulted in a reduction in portfolio risk.” It’s important to note we did not sell everything and go to cash.  Rather, we followed our process for managing risk and protecting clients given the information we had.

I love the quote from the book Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts. “What makes a decision great is not that it has a great outcome. A great decision is the result of a good process…Decisions are bets on the future, and they aren’t right or wrong based on whether they turn out well on any particular iteration. An unwanted result doesn’t make our decisions wrong if we thought about the alternatives and probabilities in advance and allocated our resources accordingly.”

That’s how we manage portfolios, through considering the alternatives and probabilities. This means continuing to manage risk until there is an adequate margin of safety. This also means that we won’t time the bottom perfectly, but that’s okay, we have done our job of protecting our client’s second most precious asset behind their family, the capital they have to support them.

The good news is that a great buying opportunity is coming. Just don’t be in a rush to try and buy the bottom.

I can assure you, when we ultimately see an adequate margin-of-safety, we will begin increasing equity risk again.  In the meantime, we are sitting on extra cash just for that reason, to be in a position to buy discounted assets.

Until then, if you’re making monthly contributions to your account, now is a great time to increase them.  Similarly, if you have cash sitting on the sidelines, let me know so we can be ready to deploy that cash when the time is right.

Remember that we have a plan and we’ve prepared for this.

If you know someone who doesn’t have a plan and would benefit from having a conversation with me, please let me know or encourage them to schedule an initial call on our website.  My clients’ needs always come first, but during times like this, you likely have friends and colleagues who are looking for help and would appreciate your referral.

Have a great weekend!

Ryan

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