Some Thoughts Amidst the Market Stress of Recent Days
by: Brian Davies, CFA – Chief Investment Officer
As of this writing stock markets around the world are being halted to deal with volatility caused by the coronavirus uncertainty and a developing oil price war. We thought this would be a great time to update you on our ongoing views and to answer some of the questions we have been getting from clients.
Be patient and remember to focus on the long-term strategy
As investors who have long-term views, we have to remind ourselves in periods like these that we have a great advantage over those who participate in market panics. Because we do not use leverage in any of our strategies we do not need to sell in times of stress. In previous writings, we talked about how leverage is a real risk as it can be a catalyst for permanent loss. With excess leverage, especially in investing strategies, you can be forced to sell at the absolute worst time. We never want to be in that situation. We want to be able to use the market’s stress to our advantage and that is what we plan to do in this environment. As the selling grows with fear grabbing hold of investors, we will use the disciplined process we have developed to make prudent decisions about what and when to buy or sell.
Oil is selling off. What does it mean for my portfolio and is it a good time to buy energy?
This past weekend, international developments in the oil industry added to the volatility that has been in place with COVID-19. Specifically, Saudi Arabia and Russia have been unable to reach an agreement on production limits, resulting in price cuts over the weekend. Energy companies have been the hardest hit in this sell-off. Our views on the energy industry have been the same for some time and will continue to be the same even despite this. We do not like the sector. The world is moving to power generation that includes fewer fossil fuels and more renewables like wind and solar. These are secular trends that have been in place for a while and are only gathering steam. The energy sector peaked about five years ago and for the most part, the equity prices of energy companies have been in a decline since then. Energy is now one of the lowest weighted sectors in the S&P 500. In all of our strategies at Shepherd Financial Partners, we have been underweight the energy space for several years. One of our underlying investing beliefs is that investments benefit in the long-term from secular themes that provide tailwinds over several years. The oil industry today, in our view, is the opposite of that. The secular theme of renewables is a headwind for that industry. Add on to this the fact that since the mid-2010s, the U.S. is now energy self-sufficient and now you have another headwind limiting the upside for the sector. Prices for stocks in the sector will become dislocated in this sell-off, but given our long-term view, there is very little chance the valuations will be attractive enough to get us to change our views. We will look to use this market correction to add risk where secular headwinds do not exist.
When will the selling end?
Part of having an effective decision-making process is understanding that you do not have all the answers. We understand we do not know when the selling will end – history has shown that nobody can time the market consistently or effectively. When making important decisions we ask ourselves: “what don’t we know and how comfortable are we making a decision without perfect information.” We don’t know when this will end. We do know that prices are being dislocated at a rapid rate and with that comes opportunity. We need to lean on the process we have in place. This process helps us take the emotion out of the equation. Emotions in times like these can lead us to make decisions we may regret in the future. Right now, our process is telling us the stock market is reaching an extreme oversold condition. The long-term risk-adjusted return on some risk assets look dramatically better than they did a month ago. To reiterate what we said when we started this piece: because we don’t have to sell, we can be in a position to take advantage of the opportunity in front of us. It doesn’t mean we will be right in the very short-term. Again, we don’t know when the selling pressure will abate. But we do know at some point it will just in 2018, 2015,2011 and 2008/2009. It just takes time.
Key take-aways during this (and all) periods of market stress
- Continue to focus on your long-term financial strategy. As long-term investors, we build asset allocations to prepare for years and decades rather than weeks and months. By taking a prudent, long-term approach, you can confront market stresses with patience and take advantage of opportunities. We believe these principles apply whether you are in the accumulation or distribution phase of your financial lifecycle.
- Diversification wins out over the long-term. Defensive allocations within balanced portfolios serve their purpose during times of market stress, and provide liquidity to make distributions for income, or take advantage of opportunities.
- We prefer not to take an all-in or all-out mindset. This is for two reasons. First, nobody can call when the market stresses will start/end, and investors can risk missing out on a rebound and the dividends earned along the way. We have found that having a goals-based approach to asset allocation is optimal over the long-term. Second, we have discussed in the past that missing the top-performing days in the market significantly impedes long-term returns. Many times, the top-performing market days are experienced along-side the worst days since these are periods of heightened volatility. Staying invested within a dynamic asset allocation aligned to your long-term needs is key to investor success.
Periods of stress frequently arise in the financial markets. While they are uncomfortable, they can be conquered by having a long-term strategy and a process to take advantage of the opportunities they present. As always, please reach out to our team with any questions that you may have.
Disclosures
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Investment advice offered through Shepherd Financial Partners, LLC, a registered investment advisor. Registration as an investment advisor does not imply any level of skill or training.
Securities offered through LPL Financial, member FINRA/SIPC. Shepherd Financial Partners and LPL Financial are separate entities.
Additional information, including management fees and expenses, is provided on Shepherd Financial Partners, LLC’s Form ADV Part 2, which is available by request.
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