Prepare for Market Recovery

Every market correction creates opportunities for prepared, savvy investors

Prepare for Market Recovery

The coronavirus pandemic has created precipitous drops in the stock markets, the likes of which we have not seen since the 2007 recession. And while it’s emotionally wracking to see the stock market take the huge swings we’ve seen in the past couple of months, it’s not unprecedented.  And it will pass.

As you can see from this chart disease outbreaks normally roil the markets. But what the chart also shows is these are temporary phenomena.

The chart depicts the before and after of the World Health Organization (WHO) declaring ‘global emergencies’ during each outbreak. That happened with the coronavirus on January 30. The markets seem to be trying to reach a bottom, yet they are still volatile and will probably continue in that vein until we reach peak stage of the virus.

Market falls before WHO Announcement May 2020

China is beginning to slowly reopen its economy, and New York is hopeful that it has seen the peak of the outbreak. However, there are still pockets of the country that have still not seen the worst of it. And as experts warn, we need to take the return to normal slowly so that we don’t spark a second outbreak.

And while the virus has horribly impacted individuals, economies, and certain industries, it’s important to put it into perspective. It is a singular event—not a series of events that are causing a long-lasting trend in the markets.

History tells us that this too shall end. And as the table below illustrates, disease outbreaks are usually followed by significant market gains.

EPIDEMIC MONTH END 6-MONTH % CHANGE OF S&P 12-MONTH
% CHANGE OF S&P
HIV/AIDS June 1981 -0.3 -16.5
Pneumonic plague Sept 1994 8.2 26.3
SARS April 2003 14.59 20.76
Avian flu June 2006 11.66 18.36
Dengue Fever Sept 2006 6.36 14.29
Swine flu April 2009 18.72 35.96
Cholera Nov 2010 13.95 5.63
MERS May 2013 10.74 17.96
Ebola March 2014 5.34 10.44
Measles/Rubeola Dec 2014 0.20 -0.73
Zika Jan 2016 12.03 17.45
Measles/Rubeola June 2019 9.82% N/A
SourceDow Jones Market Data

 

Get Ready for some Great Bargains!
Consequently, the worst in the markets is probably close to being over. And as Baron Rothschild, an 18th-century British nobleman and member of the Rothschild banking family is often quoted as saying, “The time to buy is when there is blood in the streets.”

And I believe that time is right now. But there are a few steps that I would first recommend before you plunge back in.

First, although there may be some exceptions, you shouldn’t sell your stocks during this period of upheaval in the markets. Trading stocks in this kind of market can be a crap shoot, as it’s panic selling, which rarely works out well for the individual investor. Friends who sold their stocks during the 2007-2009 recession (against my advice) are very sorry today. Right now, you have paper losses; if you sell at these lower prices, you will incur real money losses.

As I said above, this downturn is temporary. It wasn’t caused by problems in the economy. Prior to the coronavirus outbreak, we were enjoying a bull market, low inflation, and an enviable unemployment rate. And while I can’t predict when we will get back on track, I know that it will happen.

So, for most of us, that means we should hold tight to our stocks. However, there are…

A Few Reasons to Sell
There may be a few stocks in your portfolio that you may want to sell, but not because of the recent market troubles. Your reasons should be the reasons you should sell them in any market.

In this kind of market with few endemic fundamental problems, the primary reason to sell a stock is this: If the fundamentals of the company have deteriorated to the point where you do not think it can recover after the coronavirus pandemic is over.

For most of your stocks, selling is probably not the right thing to do at this time. But if you are holding shares in companies in which the fundamentals of their business were teetering on the brink of insolvency before the coronavirus hit us, then, face it, they are the likely companies to fail and not be able to spring back once we start our recovery phase.

Some of these failing indicators would be:

  • Were they losing money before the outbreak?
  • Are they overloaded with debt?
  • Were revenues shrinking before coronavirus?
  • Are they in a sector that was suffering before the pandemic?

Now, if your stock doesn’t fall into any of the above categories, I would put it through these last three tests:

  1. Are all the reasons I originally bought this stock still in place?
  2. Is my price target still valid?
  3. Can I make more money by retaining the stock than by substituting another investment?

If the answer to any of those questions is no, it’s time to bail, and go on to investments with greater potential.

If you are still happy with the company and satisfied with its potential, then keep the stock. If not, sell it and look for greener pastures—which, right now, are plentiful.

Look at the Big Picture
We’re not quite ready to begin a buying frenzy, but while you may have a bit more time on your hands right now, I would recommend that you sit down with your portfolio and spend some time reevaluating all of your holdings, with the goal of rebalancing and repositioning your portfolio for the coming bull market.

This is a step that so many investors ignore—to their peril, but it should be done at least once a year, and now is a perfect time to do it!

During the tech boom of the early 2000’s, technology companies were chased to the stratosphere by investors who had no idea what they were buying; they just saw triple-digit overnight gains, and jumped right in. But the signs of the bust were everywhere. I saw price-equity ratios as high as 1,500. Famed investor Warren Buffet stayed out of the fray, cautioning investors not to buy “what they couldn’t explain to their grandmothers”.

I interviewed a founder of the Real Estate Investment Trust industry during those heady days and asked him if he was buying any properties in the Silicon Valley area. He laughed, and said, “no, I wouldn’t touch them with a 10-foot pole; companies in the high-tech corridor have no cash; they want to pay rent with their stock options!”

It’s always important to look at investing from a macro point of view. It doesn’t matter if you have the greatest company in the world, if global markets and economies-or even the company’s sector—are trending down. It’s imperative—as I said above—to look at the big picture. And that means you must be flexible.

As you can see from the chart below, if the economy is in a growth stage, cyclical stocks, technology, and financial companies might be good bets. Alternatively, in a sustained recession, you might be more rewarded by buying utilities and energy.

Economic and Stock Market Cycle May 2020

And now that our economy and markets are truly global, that means it is essential that you also take into account what’s happening around the world and how it may impact your investments.

Do you know your Risk Profile?
But before you tackle your portfolio review and rebalancing your investments, let’s talk about you. Most investors just buy stocks willy-nilly, without a thought if they are right for them. For instance, do you consider yourself a nervous Nellie? Was your first thought after the recent market tumbles, “sell, sell, sell?”

And while no one is happy with the markets right now, are you the type of investor who is feeling pretty confident that this is just a temporary event, and you are able to just step back, take a deep breath, and realize that the market will spring back?

Another question—during the bull market of the last few years, were you able to keep cool during the periods of volatility when some of your stocks may have lost 20%-30% overnight? Or, did you jump right in to sell them?

These are serious considerations. Your investing life will be much more gratifying if you own the kinds of stocks that fit your risk profile. And I’ve designed a pretty easy quiz that will help you determine just that. Why not take a few minutes right now to figure out just what kind of investor you are?

Your Investing Profile

*Please Note: Results are to be used as a guideline ONLY and I encourage you to reassess your profile on a yearly basis.

1. I do not need a high level of current income from my investments. I am more interested in their long-term growth potential.

1- Strongly Disagree
2- Disagree
3- Undecided
4- Agree
5- Strongly Agree

2. I am concerned about the effects of inflation on my investments.

1- Strongly Agree
2- Agree
3- Undecided
4- Disagree
5- Strongly Disagree

3. I am comfortable holding onto an investment when it drops sharply in value.

1- Strongly Disagree
2- Disagree
3- Undecided
4- Agree
5- Strongly Agree

4. I am willing to accept a lower return on my investments if I can avoid significant volatility.

1- Strongly Agree
2- Agree
3- Undecided
4- Disagree
5- Strongly Disagree

5. I plan on using the money I am investing:

1- Within 6 months
2- Within 3 years
3- Between 3 and 5 years
4- Between 7 to 10 years
5- More than 10 years from now

6. My investments make up this share of assets (excluding my home):

1- Less than 25%
2- 25% or more but less than 50%
3- 50% or more but less than 75%
4- More than 75%

7. My most important investment goal is to:

1- Preserve my original investment
2- Receive some growth and provide income
3- Grow faster than inflation but still provide some income
4- Grow as fast as possible. Income is not important today

8. My primary source of income is:

1- Retirement pension and/or social security
2- Earnings from my investment portfolio
3- Salary and other earnings from my primary occupation

9. The worst loss I would be comfortable accepting on my investment is:

1- Less than 10%. Stability of principal is very important to me
2- 10%–20%. Modest periodic declines are acceptable
3- 20%–30%. I understand that there may be losses in the short run but over the long term, higher risk investments will offer highest returns
4- Over 30%. You don’t get high returns without taking risk. I’m looking for maximum capital gains and understand that my investment can substantially decline.

10. If the stock market were to suddenly decline by 15%, my reaction would most likely be:

1- I should have left the market long ago at the first sign of trouble
2- I should have substantially exited the stock market by now to limit my exposure
3- I’m still in the stock market but I’ve got my finger on the trigger
4- I’m staying fully invested so I’ll be ready for the next bull market

11. I expect to retire in:

1- 5 years or less
2- 5 to 10 years
3- 10 to 15 years
4- 15 to 25 years
5- More than 25 years

Possible Conclusions:

11-27: Conservative – As a conservative investor, you are less willing to accept market swings and significant changes in the value of your portfolio in the short- or long-term. Capital preservation is your primary goal and you may plan on using the principal from your investments in the near-term, preferably as a steady income stream. The average level of return you expect to see is 5%-10%, annually.

28-40: Moderate – As a moderate investor, you seek longer-term investment gains. You are comfortable with some swings in your portfolio’s performance, but generally seek to invest in more conservative stocks that build wealth over a substantial period of time. The average level of return you expect to see is 10%-25% annually.

+40: Aggressive – As an aggressive investor, you primarily seek capital appreciation and are open to more risk. Swings in the market, whether short term or long term do not impact your investment decisions and you have confidence that volatility is necessary to achieve the high return-on-investment you are looking for. You typically expect a 25%+ return, annually, though you do not need your principal investment immediately.

 

Allocate your Portfolio Based on your Risk Tolerance
Now that you have determined your personal risk profile, it’s time to look at some ideas of how to structure your holdings to make your investing life less stressful and more enjoyable.

Here are some sample portfolios from Charles Schwab that offer some ideas on allocating your holdings according to your risk tolerance.

Risk Tolerance Portfolios - Charles Schwab

Source: Schwab Center for Financial Research

Your Age may also Determine your Portfolio Allocation
For many years, investment pros recommended a drastic decrease in stocks with an aggressive increase in bonds, as folks aged. Here is the conventional model:
Proper Asset Allocation of Stocks and Bonds by AgeBut as the mortality rate has increased, your money has to last longer, so today, investment advisors are recommending retaining more stocks and fewer bonds as we age, as shown in this table:
Proper Asset Allocation of Stocks and Bonds by Age - 2Charles Schwab also has some ideas, broken down a bit further, for a few ideal portfolios structured for your golden years.
Age Risk Portfolio CompositionCan you see one of these working for you—maybe a bit different than your current holdings landscape, but one that might make you a happier investor?

Review and Rebalance your Portfolio
Now let’s take your risk profile and your preferred portfolio composition and compare them to your actual portfolio to see if they match up.

Don’t be surprised if they don’t, as I promise you, most investors who take these steps will undoubtedly need to make some major moves to get their portfolios aligned with their true investing risk profile.

To review your portfolio, start with a list. List your holdings by cash, bonds, mutual funds, and stocks. Next, industry/sector, market cap, U.S., emerging market, international, style: growth, value, growth and income, 3-year, 5-year, 1-year, and year-to-date returns (those will soon change for the better!), and what percentage of your portfolio that particular position holds.

For your mutual funds and ETF’s, write down the names of the companies—and how much of each the fund holds, as well as their investing style/strategy.

You can certainly do this easily on an Excel or Google spreadsheet or an easier option is on your brokerage firm’s site. If not available there, Morningstar.com has a neat—and easy—Instant X-Ray tool morningstar.com/instant-x-ray that gives you a pretty cool snapshot of your portfolio. It includes a breakdown by industry/sector, market cap, and investing style. And it shows you the year-to-date return of your holdings. To find the other returns I mentioned, you can just input your stock symbols. The site will also show benchmarks to see how your holdings are doing compared to peers. And it’s FREE!

You might also consider reviewing how your holdings are ranked compared to similar investments in the same industry. Analyst ratings are easy to find for stocks, mutual funds, and exchange-traded funds. Morningstar has a 5-star ranking system; Yahoo Finance offers a 1-5 rating scale based on Wall Street analyst reports. But consider, please that especially with analyst rankings, they are not always unbiased.

For bonds, credit rating agencies provide ratings, but know also that while they are probably better than they were prior to the 2007 recession, they are also not the be- and end-all of an evaluation.

For an unbiased review of the quality of your investments, please be prepared to use a trusted advisor or newsletter, or just roll up your sleeves, and dive in!

And don’t forget about investment fees—commissions, loads, fund fees, and potential taxes. They can make a big difference to the profitability of your holdings.

Now that you have a complete picture of your holdings, it’s time to see if they do match up with your preferred risk and age allocation.

If so, great!

If not, you may need to do some rearranging, including adding some diversification to your portfolio. Where are you over- and under-allocated? Do you have too many growth stocks, small cap stocks, mutual funds or ETFs that cover the same sectors, and maybe companies?

Now, since the markets—and probably most of your stocks—have suffered during the economic toll the pandemic has caused, please don’t start selling and buying. Let’s just get organized and ready for when the market bounces back. And as that happens, you’ll want to update your returns on your spreadsheet so that you get accurate numbers.

A couple of things to consider—once that happens. Has your current portfolio met your investing goals? If not, you’ll want to sell those holdings that are not measuring up. And don’t forget liquidity. This market rout has taught us, once again, that cash is king. So, please make sure you have liquid assets—always—of six months to one year, so that you have flexibility.

Reallocate with Sectors likely to Outperform
I took a look at the best- and worst-performing sectors and stocks—since the beginning of the year.

Best- and Worst-Performing Sectors
The best:
Sector                        Year-to-Date Return
Utilities                       -4.9%
Healthcare                  -6.4%
Technology                 -6.6%

The worst:
Sector                         Year-to-Date Return
Energy                          -42.3%
Financial Services      -23.4%
Industrials                   -21.8%

As you can see, at this point, none of them look very attractive. But the market will spring back—that’s what you need to know.

In the meantime, I suggest that you be judicious in your purchases. Until this shakes out, I would avoid stocks in the following sectors:

  • Entertainment
  • Cruise lines
  • Airlines
  • Hotels

But if you see something that looks like a great price—and it fits in with your portfolio strategy, feel free to nibble a bit. You could certainly take a gamble on some Healthcare stocks that may be in the run for a coronavirus antidote or vaccine, but that could be a pretty risky bet (usual in the biotech industry). Or you could buy Netflix (NFLX), like many investors have, as folks are staying in right now, but that is probably a temporary bounce.

But once the market begins to show signs of sustainable growth, many sectors will look pretty interesting, as the majority of stocks will have pulled back to very buyable levels.

At that time, it will be the perfect opportunity to unload the stocks that don’t meet your needs and pick up some that will be welcome—and profitable—additions to your portfolios.

And I have a few ideas in that respect.

Some Investment Ideas
As the chart above shows, during a bull market, sectors that often fare very well are:

Transportation. I think we will certainly see the airlines and trucking companies, even railroads, spring back once the pandemic is on the downside of the curve.

Financial. These companies may take a little longer. They struggled for a while in the previous bull market and had just found their feet when the virus struck. However, there will be some—especially the asset managers—who should fare very well with a new bull market.

Technology. Certainly, there will be a lot of spending, as companies have tightened their belts right now. So, look for, some exceptional growth in this arena.

Capital Goods. Just like with tech companies, demand is pent up, and once released, these stocks should do well.

As for individual stocks, I think you’ll see that once you’ve analyzed your portfolio you may need to add a few stocks from several investment styles. So, we’ve put together some ideas for you here.

Growth. A growth stock is a stock whose earnings are expected to outpace the market average, or, often, companies that are not yet profitable, but are seeing tremendous revenue increases. Earnings growth (or the expectation of earnings growth) is the biggest determinant of stock price appreciation. Consequently, companies whose earnings are growing—or anticipated to grow at a fast pace, all other market and economic factors being equal, should also enjoy above-market returns on their share prices.

The average annual market gain for the S&P 500 Index (an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ) is 9.8% over the past 90 years. Therefore, a growth stock would be expected to enjoy higher returns than the market average.

Company

Symbol Price

$

Style Industry/Sector

Analyst Ranking

Sea Limited SE 53.85 Large Cap Electronic Gaming 1.5
Ballard Power Systems Inc. BLDP 10.28 Small Cap Industrial Machinery 2.3
Virgin Galactic Holdings, Inc. SPCE 17.28 International Aerospace & Defense 2.3

 

Growth & Income. These are stocks that have growth potential and pay a steady dividend, allowing investors to cash in in two ways: appreciation and dividends.

Company

Symbol Price

$

Style Industry/Sector Dividend

Yield %

Analyst Ranking

American Tower Corporation AMT 251.42 Large Cap REIT 1.57 2.1
Easterly Government Properties, Inc. DEA 26.76 Small Cap REIT 3.88 3.88
Microsoft Corporation MSFT International Software 1.22 1.7

 

Value. Value investors believe that the market is not efficient while growth investors belief stocks reflect all there is to know about that company, meaning they are always priced at their true value. That’s called the efficient-market hypothesis. But successful value investors like Warren Buffett, chairman of Berkshire Hathaway, have disproved that concept many times over. They know that occasionally, stocks are underpriced or overpriced relative to their true value, providing investors with great opportunities to ‘buy low’.

Company

Symbol Price

$

Style Industry/Sector

Analyst Ranking

Gilead Sciences, Inc. GILD 83.00 Large Cap Healthcare 2.5
21 Vianet Group, Inc. VNET 16.71 Small Cap Info Technology 1.3
Teekay Tankers Ltd. TNK 24.08 International Oil & Gas Midstream 1.7

 

Speculative. These stocks are generally higher-risk, more aggressive stocks with uncertain prospects. But they also can provide significant returns to investors, so I call them ‘my fun stocks.’ They are stocks that might turn into ‘ten-baggers’ or you may lose all of your money, so they need to be just a small portion of your portfolio.

Company

Symbol Price

$

Industry/Sector

Analyst Ranking

Repligen Corporation RGEN 113.74 Medical Instruments 1.5
Everbridge, Inc. EVBG 121.97 Software 1.5
Moderna, Inc. MRNA 49.23 Biotechnology 2.0

 

These companies look interesting to me, and I think they all have great potential. But only you can know if they fit into your personal risk profile and investment strategy. Try a few on, and watch your portfolio grow!

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