A Difficult Time
We have much to say, so please consider this as part of a series.
During times like these, we encourage you to use credible sources for making the kind of decisions we will all have to make over the coming weeks. These sources include but are not limited to the World Health Organization, Centre for Disease Control, Public Health Agency of Canada, Local Health Authorities, etc. We’ve been doing our best to stay abreast of the breaking news and what the various experts are saying but our expertise lies in the financial markets and investing and so that is what we will focus on – where we are today, our outlook and what this means for you and your money.
Here are a few things to consider as the stock market falls:
Including today’s sell-off, North American stock markets have fallen close to 30% over the past three weeks. This decline has been particularly violent. While the oil price war between Saudi Arabia and Russia certainly has not helped, the drop has been primarily due to the spread of the COVID-19 virus and the fear of what the outbreak might mean for the world at large. We have seen big drops before; experience has taught us that cooler heads will eventually prevail and there will be a recovery. The coming weeks and perhaps months will not be easy. If you are following the markets during these turbulent times, be prepared for an emotional rollercoaster. Today, the path is uncertain but it is almost guaranteed to be bumpy.
The crisis will end. Some heavily indebted firms (particularly those with no cash and uncertain access to bank lines of credit – i.e., firms with little to no liquidity on their balance sheets) will not survive. Most other companies will work through this current environment and when this crisis ends, the share prices of many of these surviving firms will rebound.
Some individuals, institutions and funds had been overextended going into the market decline. Those with low cash balances, low cash flow and high cash needs have or will need to raise money through sales. Certain funds and individuals who were borrowing to invest and using their portfolio as collateral are now facing a precarious situation in which they must now liquidate some or all of their portfolio holdings in an effort to repay their outstanding loans. Leverage (borrowing to invest) can amplify returns in strong markets but is dangerous during rapid market declines. As the value of the leveraged portfolio falls, the ability to borrow against this same portfolio drops and outstanding loan must be repaid – this is called a margin call. Whether the call is satisfied through a cash infusion or the sale of securities at depressed prices, the loan must be repaid. Your portfolio does not make use of such leverage.
As prices move down, more margin calls are made and prices further fall further. This is a process and will likely continue to play out for several weeks. No one knows for sure how long it will last nor how much more severe it will be. What we can observe is that markets elsewhere don’t move into a settling phase until the growth in new cases of the coronavirus/Covid-19 have peaked. Such cases have not yet peaked in North America.
The popularity and magnitude of exchange-traded funds (ETFs) broaden the selling. By dollar size, many ETFs are structured to mimic the stock market. For example, there are many ETFs that hold proportionate positions in all 500 companies of the S&P 500 index (a proxy for the U.S. market). As investors sell these ETFs, the managers must sell each and every company in the index in order to keep the ETF properly weighted. The result is indiscriminate selling of both good and bad companies in the index. On some days, the share prices of 498 of the 500 companies have fallen, scaring investors even more and leading to further sales. In turn, these broad moves trigger more sales by the algorithmic quant traders (“computer trading”) as certain levels are hit, magnifying both declines and recoveries, creating large swings in market movements.
You should be aware that some have called for the markets to be shut down, as they were after the 9/11 attacks. The intention would be to stop irrational and indiscriminate selling, and disorderly market swings. It is a good time to concentrate on taking care of family, friends and neighbours, the most important people and things in your life.
In this vein, it is important to try and take a step back to make sure you are financially stable and not overly extended. Many wealthy individuals and companies are reviewing their budgets and their spending to see what can be deferred, if needed.
Please know that we have your back. All of us at Exponent are working tirelessly to make some sense of things and to understand where the vulnerabilities and opportunities are. We are living through a very fluid situation in which the information sometimes changes by the day. We will continue to reach out to everyone and to keep you up to date on your investments. Remember that we have constructed your portfolio in such a manner that it is designed to withstand the bad times and prosper during the good.
You should also be aware that there are some positives to current events. From a macro perspective, low interest rates help those who borrow and while low oil prices hurt oil and gas producers (and the provinces and states within which they operate), they are a big benefit to energy consumers – individual, corporate and government.
Stay healthy, stay well and keep in touch. And don’t hesitate to get in touch.
Tyson Charlebois and Kevin Charlebois