Here we go again. The market has broken through the barrier and we are now officially in a bear market. Markets like this are always scary, but everyone should be reminded that we have a plan, and this too shall pass.
All of our clients have heard me say this (probably more frequently than they like), but you are going to hear it one more time: Our number-one job at Iron Capital is to make sure our clients do not make The Big Mistake. The Big Mistake is selling out at the bottom of a bear market and then not getting back in because of fear. That is job number one. It is like the Hippocratic oath: first, do no harm. If we do nothing else, then we have helped our clients.
We accomplish that goal by setting downside thresholds. We ask every client, over a one-year (12-month) period, how much downside can you take without making that big mistake? Those reference points are noted in every single client file. At times like this we are monitoring those risk levels and will be taking necessary measures to protect our clients the best we can. At this moment, no client has breached her threshold.
That is step one. As I tell my basketball teams, winning begins on defense. So here is the bear market strategy. We first want to protect our clients as mentioned above, but even before the threshold is reached, it is our goal to protect as much as possible. No one is going to like their statement come the end of this quarter, but losing less is actually one of the keys to long-term investing success. The importance of this is simple math. If a portfolio is down 20 percent, then one needs a 25 percent return to get back to even. If that same portfolio is down 30 percent, then that same investor needs a 42 percent return to get back. No one, myself most of all, likes losing any money, but losing less in these downturns is very important.
However, winning only begins on defense; a team must score if they want to win. When this downturn ends (and it will end), there is going to be a powder keg of stimulus lined up. To begin with, there will be great pent-up demand from consumers who have not been able to do all the things they wish to do. Oil prices have been slashed and this put more money in consumers’ pockets. Governments are also lining up to provide stimulus. The recovery should be rapid in the real economy, and the market always outpaces the real economy.
We play defense now to have the ability to play offense soon. How we play offense will be impacted by the downturn. After the tech bubble burst, many areas of the market rebounded rapidly, but it took a decade for those big tech companies to get back to where they had been. How we go up is not usually a mirror reflection of how we came down. Some companies and industries may bounce back faster than others. Prudent investors take advantage of downturns to improve the quality of their portfolio, which helps in the rebound.
Our biggest concern going forward will actually be the bond market, not the stock market. Bond prices and bond yields are inversely related. In other words, they act like a seesaw. When yields – the interest rate the bond pays – go down, bond prices go up. Bonds are more expensive today than at any time in our history. They will remain safe as long as we are in crisis mode, but once this is over, they are practically guaranteed to be losers. This will change asset allocations.
These are the things we are working on as I write this. There are lots of things I don’t like about this crisis; I have written about some already. However, all we can do is focus on what is in our control. We can’t control what happens to us, the virus, or society’s response to the virus. We can’t control that computerized short sellers are now allowed to drive the market down over the course of a month as much as historically would have taken 18 months. We can’t control any of that, but we can control how we react. We will do everything in our power to react prudently.
Chuck Osborne, CFA