Let’s see how the current environment looks like.
Here are some uncertainties that govern investors’ reactions over the past 50 days:
- Nobody knows how long will the pandemic last. Obviously, the longer the worse and there is no indication of slowing down.
- Nobody knows if people who get sick will have immunity over the next potential virus wave.
- Nobody knows how the transition period back to normal economic activity will be achieved and how long it will take.
- Nobody can estimate the real economic damage to the backbone of the economy → SMEs
- Nobody can estimate the second derivative of the sell-off effects, i.e. what will happen with the fallen angels and lack of liquidity.
A few facts about the virus:
- Death rate varies between 0.5% – 7%, depending on population age, ICU coverage and extent of population testing.
- Most of the patients do not present symptoms for many days, which makes the virus extremely effective in spreading.
- No vaccine is expected before the next 12–16 months.
Now, a few economic facts and hard data:
- Almost 50% of US corporate debt is BBB rated now and with most of the world’s population being under lock-down, it is no rocket science that big part of them will fall below investment grade.
- Almost 3.3M Americans filed for jobless claims last week. This is 5x the previous record of 1982.
- The Fed’s balance sheet just exceeded $5 trillion for the first time.
- Markets are deep into bear market territories.
The Covid-19 effect:
Now, it is important to clarify that Coronavirus will not disappear overnight. It will be a long and gradual process lasting 3–6 months. I am afraid the worse is yet to come for markets across the world. The detrimental effects in the real economy are becoming more obvious day by day and translated into spikes in unemployment, mortgage payment delays, lack of liquidity and financing for SMEs, cuts in Capex and supplies, and lastly corporate and personal defaults. This is a self-feeding loop probably leading to what economists describe as secular stagnation.
The Central Banks were not ready to face such a crisis. Rates were extremely low already and their balance sheets were already loaded with a lot of public and corporate debt. Another stimulus plan may be the only solution now, but it is not sustainable in the long run.
My opinion is that markets will remain into bearish territory for many months after the “end of Covid-19”.
What can ordinary investors do to prepare?
- You cannot time the market. You never could and definitely cannot start now. So, instead of guessing whether stock markets are going to rise or fall further after Covid-19, adopt a longer horizon. Get some exposure in the stock market but do it for the long run. There is no point to pick the best mutual fund, as most of them underperform the markets. Go for a cheap ETF. Robinhood or Vanguard will probably do for most jurisdictions.
- Normal diversifiers like corporate bonds are always necessary for an all-weather portfolio. However, keep in mind that in every liquidity crunch most of the risky assets move together and move downwards.
- Safe havens, like government bonds (US, Germany, UK) still have their place in your portfolio.
- Look for market-neutral alternatives. This can be alternative types of exposure, investment styles, methods, etc. Look for market-neutral assets and funds. At the toughest periods, the market-neutral investments will keep your portfolio beating. It is true that market-neutral exposure is not the easiest thing to achieve as an ordinary investor, but there are a few apps that try to achieve that. I find Daedalus Investment Platform interesting, but I am sure there will be others as well for jurisdictions not covered.
- Keep some cash. Not only as a safe haven but to also exploit opportunities when you identify them.
Summary: These are hard times for the markets and events that are unprecedented for our generation. It is and will be tough, but the best we can do is be prepared both for the virus (social distancing & healthy routine) and for our long-run financial plan.
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.