Searching for Support

The New York Stock Exchange (NYSE) suspended trading for 15 minutes just after the opening bell this morning. This happened because the NYSE hit the first of three circuit breakers that call for a trading curb. These circuit breakers suspend trading when the markets drop 7%, 13% and 20% from the previous days close. The Dow declined by -2,046 points at the start of the trading session, which was a 7.4% decline. It ended the day down -2,013.76.

The Asian markets and futures pointed to a sharp decline at the U.S. market open on Sunday night. Investors reacted to this information by setting up sales at the start of the trading session. From there, computer generated orders took over until the session was halted for 15 minutes. The market rebounded slightly after trading resumed, but after eleven negative trading sessions in a row, a downward trend is emerging.

Finding the Support Level

This latest round of volatility has been caused by a spat between Russia and Saudi Arabia over oil production. The energy sector is leading market declines because of this. Of course, we’re still in the midst of the Coronavirus scare. This has created a rare supply and demand side disruptions to the economy.

Everyone invested in stocks wants to know when the decline will end. Obviously, there’s no way to know this until after the fact. What we can do until then is to attempt to find the market’s support level. A support level refers to a price level what an asset does not fall below for a period of time. This can give us an idea of where the market bottom is at.

Finding a support level is a form of technical analysis. While it has a large following, it’s often akin to reading tea leaves. Technical analysis may assist with day trading, but it has little impact on choosing investments in a diversified portfolio. Financial planners rarely concern themselves with the day to day movements of the markets. That doesn’t mean we ignore it though. Technical analysis can provide insight on when and what market moves should be made in the near term.

What this Means for Investments

The stock market has been overpriced for some time now. Fed intervention, tax cuts and deregulation have caused markets to overheat in the past. This appears to hold true this time around. The correction we’re seeing was to be expected. What does this mean for investors? It means everything is on sale.

This is a normal part of the business and investment cycle. In fact, we just went through this a little over a year ago. The most recent market correction was at the end of 2018. If you bought into the S&P 500 right after the correction ended at the start of 2019, your portfolio would have grown over 29% last year. The average market correction typically lasts between 60 – 90 days. Afterwards, markets tend to bounce back.

2018 bear

This pullback will provide a window of time for investors to purchase long term investments (5+ years) for a discount. In order to do that though, you’ need to have funds available. That’s not going to happen if you’ve been all in on stocks. In order to buy this next dip, you needed a pool of funds waiting for the opportunity.

How I’ve Prepared

Before I begin work on any portfolio, I spend time with my client’s attempting to better understand their needs. The first step is to prioritize financial goals. Once I understand this, I review what resources are available. I can calculate what rate of return is needed to achieve those goals from that point. Advisors cannot ignore market risk when building a client portfolio, however.

For the most part, your portfolios use a mix of investments that have historically meet the targeted return rate with the least amount of risk possible. The allocation mix gives us a good starting point. The problem with using historic data is that it cannot anticipate future trends. This is where my experience and understanding of history helps position investments.

Over the last couple of years, I have slowly shifted managed portfolios towards assets that offer more stability. For equities, I have focused on more conservative defensive investments rather than the cyclical investments that grow during an expansion phase of the economy. We purchased these investments at a discount since they were out of fashion. If the economy enters a recession, these will be the investments that hold their value better than the alternatives. Today’s sector results illustrate that point.

Defensive 0309202
Sensitive 03092020

For bond market investments, I have focused on higher quality bond ratings along with shorter term maturities. I’ve done so despite allocation models calling for the opposite at times. The result has been lower yields but far more stability. The chart below compares how the S&P 500 index has done this week when compared to two of the top bond funds that I currently use (PIMIX – PIMCO Income Fund and LALDX – Lord Abbett Short Duration).

bond vs stock 2020

What’s Next

The selection of investments has been an important part of the asset allocation process in recent years. Another part of my strategy has been to hold funds in reserve for this eventuality. This has been accomplished a couple different ways. The first has been to periodically rebalance portfolios. As the stock market grew, we sold high performing assets, which were primarily equities. The proceeds of those sales went into the more stable bond market funds. In essence, we were locking in those gains.

Another strategy we used for newer clients was dollar cost averaging (DCA). A DCA strategy is where you invest the same amount of funds periodically over time, which this usually occurring on a monthly basis. The result tends to be lower investment costs over time. I also recommended this strategy because it meant we would have cash on hand to purchase into the stock market if a correction occurred.

I suspended those automatic investments because of the market activity over the last few weeks. Between this and the bond holdings, most clients have a stable pool of funds available to pick up equities at a bargain. A problem with this is that we have no idea how far the markets will recede.

A week is too short of a time frame to uncover a trend. Losses during a recession average around 33% (going back to 1929). We’re down 19% form the peak of the market just two and a half weeks ago. The average recession lasts 17.5 months. We may have a way to go before we find the bottom.

Technical analysts are already looking to understand where the support line will fall. If these declines become part of a longer-term trend, their work will give us an indication when it would be best to use the funds we’ve held in reserve. Market analysts are predicting a U-shaped recession if one does materialize. While these recessions are painful, a U-shaped recovery will give us a longer timeframe to target a bottom for prices. This means everything will be on sale for longer.

My plan going forward is to slowly rotate investments away from the conservative allocations that have been held and back to the ‘normal’ allocation ranges for a balanced portfolio. The timeframe for doing this remains open, however. Over the last few years, we’ve seen economic policies enacted that parallel decisions made in the past. The result has been uneven growth and extreme market volatility.

Coronavirus has been the catalyst for the most recent market losses, but my view is that it simply brought to light issues I have been concerned with for some time. We have no way of predicting where the markets will head over the coming weeks. One thing that we do know is that this will eventually pass. Keep your long-term goals in mind and pass along any questions you may have about the strategies I’m using to help get you there.