I've had some dark nights of the soul recently. They've been prompted by COVID-19.
My concerns aren't related by my direct situation, but more about vulnerable loved ones and the world at large. We have some heart-wrenching months (years?) ahead.
Times like this also make me question my worldview and beliefs, including many of the beliefs I've articulated in this blog. Consciously and unconsciously, I've been stress-testing my ideas during these unique times.
One of the things I've been questioning is my devotion to index-based investing.
I've long been an advocate for index-based investing. My view has been that you can't consistently beat the market, or find someone who can. I believe you should instead focus on investing in a way that's appropriate for you, diversify widely, keep fees low, and instead of beating the market, making sure you don't get beaten by it. (I'm in good company: Warren Buffett preaches this gospel as well.)
Challenge your beliefs
I will never hold a belief so strongly that I won't question it.
COVID-19 and its impact on financial markets has made me challenge my beliefs.
The S&P 500 hit an all-time high of 3,393.52 on 19 February 2020. As I write this (21 March in New Zealand) it sits at 2,304.92. That's a 32% drop.
The NZX 50 was as high as 12,073.34 on 21 February 2020. As I write this it sits at 9,196.42. That's a 24% drop.
The novel coronavirus wasn't a secret at the time of those highs. It was covered by mainstream media during most of January. Yet by mid-February its impact hadn't been priced into the market.
Could I have predicted this downturn?
More than any other event in my adult life, I feel like I could have predicted this more quickly than the market.
I first published an article about COVID-19 on 26 February. (The S&P 500 was at 3,116.38 ("only" 8% down) and the NZX 50 was at 11,261.16 (7%). I'd been reading and thinking and talking about it for some time before that.
My feeling in retrospect is that if I'd had the courage of my convictions, I could have switched my investment before the market crash. For example, I could have switched my growth-oriented funds to conservative-oriented funds and protected myself from the subsequent crash. If I switched back to growth now, I may have protected 20% or so of that portion of my wealth. Likewise, I could have emailed clients to let me know what I thought, and given them an opportunity to do the same.
This is easy to say in retrospect, hindsight being 20/20 and all.
Coulda, shoulda, woulda
I feel like I could have predicted this more quickly than the market.
I feel like if I had the courage of my convictions, I could have switched investments in time before the crash.
But as I reflect on this, and actually scrutinise to my intuitions, I didn't have the courage of my convictions because I wasn't convinced at that point.
I'm falling prey to the hindsight bias. I've also been rationalising, constructing a narrative that aligns with these intuitions.
The information at that point was more limited than it is now, so there was a wider range of possibilities at that time than what there are now.
I thought COVID-19 was important enough to break my general rule of not writing about current events. But I still wasn't sure what its impact would be. I thought a bad pandemic was likely at some point, but I said that "Maybe it'll be the coronavirus COVID-19. Maybe it won't be."
In that article I said (and still agree) that "no one knows exactly what will happen in relation to COVID-19".
I went as far as saying that "COVID-19 shouldn't impact your investment decisions".
So that's interesting. It's a clear illustration that, despite my very human inclination to think I could have picked the market, I still wasn't certain about what would happen at the time.
Over the course of the last two weeks or so, it has become clear that COVID-19 is bad news. Then, I believed it had the potential to be bad news. For all I knew at that point, it could have ended up more like SARS or MERS or Ebola or the swine flu. More than three weeks later, we know a lot more and we're many degrees of certainty clearer on the magnitude of the issue.
If I'd been right...
Let's say my intuitions were right. I'd been reading about COVID-19 and, fully understanding exponential growth and confident that the response by various countries would be woefully inadequate, I was confident that something was going to hit the fan.
I could have reduced my exposure to growth assets, by investing in a more conservative managed fund.
To make this switch worthwhile, I would also have to be right a second time. I'd need to make sure I invested back into a more growth-oriented fund before the market fully recovered, and ideally when it's near its lowest.
Let's say I'd done this. I may have saved myself a 20% loss, which is like beating the market by 20%.
What does that say about my ability to actively pick the market?
It wouldn't follow that I should be embracing active management.
The current situation is a rare event: a 1-in-10 years event, if not a once-in-a-generation or once-in-a-lifetime event.
What's the probability of picking more frequent events? Low.
What's the probability of me picking other events and making the wrong calls? High.
Maybe I'd be able to pick something like this once every 20 years, and save myself a 20% drop. That's 1% per year in increased returns, which is pretty good. The wrong predictions (which would involve losing money) would probably balance this out though.
Could I have worked out which companies would benefit and which would suffer?
To confirm (or disconfirm) my confidence in COVID-19 alone, I'd have had to do a lot more research.
There's no way I'd also have had time to investigate specific companies and the impact that COVID-19 would have. I'd guess airlines and tourist-focused businesses would suffer, and technology companies like Netflix and Zoom might thrive. Amazon, too. But I'd need to be confident in the fundamentals of those companies in the first place and make sure that any predictions or expectations about COVID-19 (or anything else, for that matter) weren't already baked into the share price.
If I wanted to beat the market in general, I wouldn't have had time to pick specific shares. Time would've been of the essence.
Too much uncertainty, and not enough hours in the day.
To the extent I coulda picked the market, it woulda related to the sharemarket in general: it would have influenced my tactical asset allocation, or split of defensive assets (such as cash and bonds) relative to shares. It wouldn't have been in relation to individual shares.
I'm back where I started
Diversification, low fees, and investing in a way where I may not beat the market, but I don't get beaten by he market, is still fine with me. And since I'm investing according to a long-term plan, a downturn is absolutely fine. It's part of the process.
An aside: I'm glad I don't hold myself out to be a stock picker
My understanding is that there are two types of financial planners right now. One type is dealing with a lot of concerned clients. One has a lot of clients who are fairly sanguine about everything that is happening. From what I've heard, there isn't a lot of middle ground: it's either/or.
I'm in the latter category. I've had one or two clients who have been concerned, and I've had a couple of clients who have used it as a reason to touch base and chat. But I've been bracing for lots of questions and... tumble weeds.
If I'd represented myself to clients as being able to outperform the market, I suspect I'd be fielding a lot of concerned calls right now. This would be demanding enough. But it would also be at the same time when I would need to be focusing more than ever on what is happening, so I can continue to pick stocks and beat the market for my clients.
(It would also be at a time when my income was reducing, since most advisers charge clients a % of their investment portfolio. A big reduction in portfolios means a big reduction in income. This isn't something that impacts me. But that's another conversation.)
I'd had a few clients who have moved away from advisers like this, or have a portion of their portfolio with an investment manager alongside some index-based investments. Interestingly, they feel a lot better about their index-based investments. At least they know exactly what the fund is doing, and they don't have to worry about what their investment managers are (or aren't) doing. This certainty in process seems to be removing another source of potential uncertainty and anxiety for these clients.
I share this because (a) I find it interesting, and (b) to be completely transparent: it creates an incentive for me to want to keep believing what I believe. There's a fine like between being rational and rationalising, and sometimes the best you can do is be open and transparent about these things.
Will there be a further downturn?
Share markets are down about 30% from what they were a few weeks ago.
They may go down further. Lots of people think that might be the case. This morning, someone whose opinion I respect said that he thinks shares will dive once US sees the real consequences of COVID-19 up-close. Alternatively, shares may stay where they are for a while, albeit with a lot of volatility. Shares could conceivably even go up, if the consensus becomes that the recent crash was an over-reaction. It all depends on whether current expectations (which are priced into share prices) are better or worse than expected.
I recently "thought out loud" about what this means on Twitter:
Maybe the "fundamentals" built into prices were wrong in the first place, so a 30% drop (and potentially more) might represent an adjustment closer to what prices should have been.— Sonnie ☀️ Bailey (@sonniebailey) March 21, 2020
I'm not a stock picker and I'm not going to bet against Mr Market. I'm not going to say whether the share market is going to go down further or stay stagnant or rise. I don't know.— Sonnie ☀️ Bailey (@sonniebailey) March 21, 2020
I'm not making any predictions and I don't want to minimise what's happening. It's terrible. I'm especially shocked and angry about some of the incompetence (indifference?) being displayed by certain leaders, especially overseas. I'm just trying to process it like everyone else.— Sonnie ☀️ Bailey (@sonniebailey) March 21, 2020
In short, I'm not as confident of a big fall now (although it's very possible, and there are good narratives and explanations supporting this scenario). If I'd been "smart" enough to switch to conservative several weeks ago, I would probably have switched back to growth by now, and walked away with my "gains" (or lack of losses).
But who knows. It's not something I seriously entertain because I'm disciplined (lazy?) enough to not touch my investments which are earmarked for the long-term.
As always with predictions about the market, there is a wide range of possibility and I have low certainty about what will happen.
Despite my initial intuitions, I don't think I could have picked the market for what is probably a one-in-a-generation event. It hasn't changed my conviction that you can't beat the market.