Joke Of The Week
The bull and bear go out for a coffee (maintain distance).
The bull proudly says: "Best three days for the S&P 500 since 1933".
The bear responds: "Exactly!"
How To Survive The 2020 Bear Market?
Last week I suggested investors needed a plan to significantly increase their chances to successfully negotiate this year's Bear Market in global equities.
This week I am adding my five cents worth about what to take into account when setting up such a plan.
Let's start with the positive news. Every Bear Market, Grand or Small, offers the ideal starting point for outsized investment return, once the story of misery and despair has run its course.
We only have to look back at the final week of 2018 to back up that statement. Once the selling stopped, after four months of relentless down-draught, Australian share market indices rallied circa 20% over the following six months carried by banks, resources and other previously beaten down cyclicals. And that was after a rather mild pull-back that in Australia didn't even make it to -20%.
It is thus of no surprise that once the wildest of wild gyrations have been replaced with calmer moves in share prices, the financial sector is back to doing what it does best: trying to look forward, calling the bottom, and identifying attractive opportunities.
There is no judgment in that sentence. This is how the financial sector operates and most professionals in it have that special gene that never stops looking at the brighter side of life. Pessimists never get rich, etc I am sure you've heard all the mantras.
I am now letting out my naughty side, and I hope you don't mind, but reminiscing on past observations the track record for most to accurately identify "the bottom" in a Bear Market is far from great, and I am now being polite.
Back in 2007, once we had a Big Sell-Off followed by a quick reversal, many were prepared to call "the bottom".
As it happened, they tried again in the second quarter of the following year, and again by mid-year. Later that year more attempts appeared in print, and that was before that last Big Sell-Off dragged markets into early March of, by then, 2009.
Only then, finally, career-defining accurate calls about "the bottom" were made.
What we, the smaller sized investors, should keep in mind is that professional fund managers are wired to take risk. They are usually quite good at it.
But if it turns out they moved in too early, or bought the wrong stocks, most are not losing their job over it, or if they do, they can probably move on to the next endeavour.
In contrast, many years after the Bear Market of 2007-2009 had been relegated to history, I would still hear stories about self managing retail investors that had been wiped out, and many have never returned in the share market.
Recently I heard about portfolios of half a million dollar having been annihilated to virtually zero because of leveraged exposure to the Bull Market that so abruptly ended only a few weeks ago.
I know, the first thing that comes to mind is always: what exactly was their financial advisor thinking? Goal number one for the rest of us: let's make sure we don't end up in similarly dire straits.
The share market can be a wonderful creator of long term wealth, but we should always be mindful of the risks that lay within, in particular during times of pandemic, global recession, and another heavy collapse in the oil price.
Bear Markets Are A Process
Forecasts about "the bottom" in this year's Bear Market are all based on the assumption the world has only one problem to look after: a nasty covid-19 pandemic that at some point will have largely run its course, hopefully soon.
This is not dissimilar from the situation in 2007 when it was widely assumed the Americans would take care of their subprime-related liquidity problems, and that would be it.
Little did we know. Next up followed a rapid boom-bust cycle in oil markets, virtually guaranteeing an economic recession later in the year. Then China tripped over, causing the most severe sell-off for commodities and related share prices in modern human history.
And after that we still had to find out that the US housing and financial products related problems that had surfaced in 2007 were well beyond what any of us had ever imagined possible up to that point.
The message I am trying to get across here is that Bear Markets are a process. They develop in line with whatever comes out next in terms of bad news.
Most of the smaller Bear Markets have one key problem that needs to be dealt with. In 2012 it was the ECB that promised to do "whatever it takes". In late 2018 it was the Federal Reserve that reversed on its policy.
It is possible that to hunt the Big Bad Bear back in his cage this year all we need to see is a regression in global infection numbers, and that will be it.
It is also possible that more bad news is just about to come out of the woodwork. There is still a global economic recession happening in most economies around the world.
Combined with the collapse in oil prices, this is as good as a solid guarantee that a lot more negative developments will take place.
What we don't know is whether any of the forthcoming bad news stories will be strong enough to push share prices further onto new lows. Only one way to find out.
Equally, what history shows us is that Bear Markets tend to end unexpectedly. I don't recall anything special happening during the first week of March 2009 and virtually nobody thought in late December 2018 next stop 20% higher by July!
So there is a real dilemma for investors. On one hand there are plenty of once-in-a-decade opportunities in equity markets, on the other hand we don't know when or why or whether share prices can still become a lot cheaper - or not.
What if tomorrow's rally proves the real thing? How much will we blame ourselves if we miss out on taking advantage?
You Need A Plan, Not The Bottom
Investing during a Bear Market is about trying to balance the two opposing scenarios. You don't want to take a massive hit on your capital, and potentially handicap your future ability to generate returns, but you also want to be in the market when that big unexpected rally sweeps share prices to a significantly higher level.
The universal (and best) advice for investors sitting in cash thus remains the same: don't try to pick the bottom. You most likely won't be able to. If you try to pick the bottom, with the intention of then moving in big you most likely will miss the opportunity.
A much better strategy is to allocate small amounts to stocks you really want to own once all this is over. Accept that after you buy, the share price can (and probably will) go lower, at some point. This is why you move in small steps.
This is also why you need a plan, a list of stocks on your personal radar, and a mapped-out strategy of what exactly are you trying to achieve? The latter is less straightforward than most investors realise.
Let's start off with the basic observation: with exception of very few stocks in the share market right now (Fisher & Paykel Healthcare ((FPH)) comes to mind) ALL stocks are by now "cheap".
Many stocks are cheaper than many others, and some might look exceptionally cheap, but there is very little discrimination going on in these markets, except for degrees in volatility and share price weakness.
All stocks are cheap, but they do not all offer the same kind of opportunity. This is why it is paramount for investors to know what exactly they are after.
For example: a stock that has been clobbered by -80% might possibly represent the most upside when that sustainable, coming-out-of-the-bear-market rally arrives, but it does not by default represent a great longer term, buy and hold type of opportunity.
If you are looking to jump quickly on and off opportunities, stocks that have fallen the most would now be your favourite hunting ground.
Investors looking to (re-)build long term investment portfolios might want to look the other way, however. I am guessing you are much better off searching for dividends that grow and are sustainable, and for business models that can withstand the challenges and shocks that seem to come along regularly in this ongoing era of below-trend economic growth.
To put it more bluntly: many of the shares that have fallen a lot more than suggested by the index belong to companies that looked "cheap" and were operationally struggling before this Bear Market arrived (see also the February reporting season locally).
You are hopefully not assuming these companies will somehow transform into a much better version of themselves in the midst of this maelstrom of negative developments?
I fully agree with expert voices elsewhere, cheaper looking "value" stocks will outperform during the recovery from this Bear Market, but this will be predominantly because their share prices have fallen more deeply, and their operations are more leveraged to future recovery.
But once this process has run its course, it'll be back to old warts and smelly wounds.
Which is why I believe many long-term investors will be much better off by focusing on those companies that looked strong, solid and in excellent shape before this Bear Market pulled down their share price.
With the occasional exception, those companies will still be better, healthier, and growing more sustainably than their cheaper (and lower quality) peers who offer more upside, potentially, in the short term - when that final rally arrives.
Tomorrow Will Be Different
It gets more complicated, still.
I sense a general assumption that what we are experiencing is simply a temporary interruption. Soon all will be back the way it was pre-February seems to be the general look-through-the-crisis view.
But, again, I think this will prove way too simplistic. Bear Markets of this character and magnitude change the world. Investors who simply assume everything old will soon be reinstated are setting themselves up for major disappointment, I believe.
I suspect, for example, that global travel might remain more subdued for much longer than anyone of us is currently willing to contemplate. Geographical borders will remain less-friendly after this pandemic.
The corporate sector in particular is now discovering the ease and benefits from online conferencing and working from home. Are they really going back to booking as many flights as before?
Corporates might also consider reducing headquarters office space. Possibly with less staff too, of which more might be allowed to (at times) work from home.
Similar expectations seem but valid for online shopping and services, more electronic transactions (less coins and paper money) and a general drop in popularity of ocean cruises.
Most importantly, I believe, the damage that is currently being inflicted on already over-indebted Australian households might usher in a new era of subdued household spending long after the current crisis has run its course.
Mortgage and debt-relief are most welcome, of course, and I truly believe governments the world around have no alternative but to provide excessive support to their population and businesses, but further out those debts still need to be paid off, irrespective of the damage that is currently inflicted on cash reserves and incomes.
This year's financial situation for Australian households doesn't look any rosier now that property owners are expected to "share the burden" which in many cases translates into no collecting of the rent and thus loss of income, while portfolios in the share market will be hit by listed companies deferring, reducing or scrapping altogether their dividend payout to shareholders.
Soon, I believe, property prices will fall in value.
Capital Raisings And Other Risks
Locally, I believe one key risk for retail investors is that companies will announce capital raisings to either pay off debt/fix the balance sheet, or make sure they don't run out of cash.
As already shown by recent examples provided by Cochlear ((COH)) and oOh!media ((OML)), these additional share placements are executed at significant discounts, even after the share price shellacking, and retail investors might not be offered the opportunity with all the spoils reserved for cashed up institutions.
Depending on specific circumstances, large capital raisings at depressed share price level not only weigh upon the share price, they also dilute a significant share of the future upside potential. In the above two examples: this will prove more so the case for oOh!media and less so for Cochlear.
Investors should check their list and/or portfolio because many more of such capital raisings will be announced in the days, weeks, and months ahead. You can pretty much consider this a personal guarantee.
Those with a healthy memory will remember fresh capital raisings equally became one of the defining features during the Bear Market of 2007-2009.
This time around, companies that are being mentioned as a likely candidate for fresh raisings include Tabcorp ((TAH)), Star Entertainment ((SGR)), Oil Search ((OSH)), Woodside Petroleum ((WPL)), Boral ((BLD)), Computershare ((CPU)), James Hardie ((JHX)), G8 Education ((GEM)), Link Administration ((LNK)), Ramsay Health Care ((RHC)), Transurban ((TCL)), Sydney Airport ((SYD)), McMillan Shakespeare ((MMS)) and Vocus Group ((VOC)).
The problem for most companies is that business spending plans and balance sheets all date from pre-February and none incorporate an extreme economic shock as is currently upon us.
Many will try to avoid raising fresh capital through deferring spending, reducing costs and (if they can) sell assets or take on more debt, but a number of companies might also simply move early in order to "get it out of the way".
Those who wait until they are forced to execute quickly will be subjected to larger discounts. That's how this works.
Investors should note Bapcor ((BAP)) was seen as a likely candidate for a capital raising, but management organised an investor call on Friday assuring there would be no new equity required.
If somehow I have now given you the impression that investing in the share market in 2020 is a lot more complicated than simply buying into a cheap looking stock, than damn right you are getting the message.
In terms of macro-risks, the most obvious is the sinking oil price, of which I am 100% certain investors are underestimating the impact on the industry's spending, profitability and balance sheet vulnerability.
There is no doubt in my mind the significant fall in the price of oil will trigger a lot of negative news in the USA where a direct link exists into high yielding corporate bonds.
It is difficult to predict when exactly, or how this process will play out, but I have little doubt the world is watching this very closely.
Investors who are not sitting on the sideline with a load of cash, should use every opportunity to re-adjust their portfolio for the fact that the world has now changed rapidly since mid-February.
A bad decision made in the past doesn't get any better during a Bear Market. This is the ideal opportunity to improve the overall quality and sustainability of your share market exposure.
But first: make sure you have a plan. Know yourself, your goals and needs, your risk appetite and your time-horizon. Only then will this Bear Market represent a true opportunity for you.
Best not hesitate to use it well.
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Very well said Rudi.
Great article. Thank you Rudi.
Excellent Rudi, thank you.
Awesome article Rudi. Thank you.
So good to hear from someone other than the regular fundies that are in buy mode as the market is bottoming, as they say. I'm not a professional and I can see that this event is far from finished. Thanks for your detailed insight.
I really don't agree that you can say that most stocks now look cheap. the earnings are going to be clobbered but it is very difficult or impossible to calculate by how much. and if the E falls by 50% but the P falls by 30% then the company PE ratio goes up despite the share price big fall ! it is also likely that the economic ramifications of this disaster will go on for a lot longer than just the virus death numbers.
Excellent article. Thank you
Excellent article Rudi. Finally someone mentioning the corporate bonds in US for shale oil companies. once they start to default, that's when everyone will realise its not gonna be a V-shaped recovery. only reason russia & saudi's are pumping oil in the mkt below cost is to bankrupt US shale companies. they are not taking so much pain for nothing.
Excellent article - thank you
Excellent article Rudi
Reality Check article, Well done.
Excellent info, thanks. I am pretty much a straight talker and have to admit, I am totally confused by the jargon and almost misleading information being touted by a lot of people. Possibly, it's to promote their own brands and shares or see their names in print. Idont know. I DO know I am NOT a professional investor but even I can see there are huge problems ahead for a long time. YouTube videos of the Great Depression and in particular, The Spanish Flu are following almost IDENTICAL patterns to this current pandemic and economic crisis. Even the strategies of shut down, isolation and restriction of movement was conducted in America to stop the spread. At one stage it was compulsory to wear face masks. The reason I like your insightful posts are because you put it straight. It's not pessimistic, it confirms first, we are not idiots to feel afraid, second it creates better options because we can make informed decisions. I wish there was a little more control for Super Fund members. I wanted to sell my shares when they were just starting to fall at the beginning of this crisis. I put in a switch request while I had lost very little, but by the time it was processed a WEEK later, it was too late. I have been trying to figure out how to manage my funds myself but so far no clue. So, as a safe haven for my remaining coffers, I changed everything to cash even though I MIGHT miss out on the big upswing. Greed vs need. I can't afford to lose more than I already have. I read on this site "keep your powder dry" advice from a billionaire to small investors. It resonated. I do NOT like superannuation funds because of the way we were forced into joining, and can't see a way out, or ability to QUICKLY respond and take advantage of market conditions, or even which particular shares to invest in. I WANT to choose my shares but only if I have the ability to move quickly. Otherwise I will stick with cash in Super because the Switch process takes too long and the risks of losing more in one week are too high.
Good balanced article. Thank you. Also.... To R M on 8th April comment I hear what you are saying. I was similar back in 2007, but learned a lot. And over the course of that bear market I still preserved most capital as it kept going down further. It is not too late yet. In terms of being able to switch quickly. There are a funds that you have choice to rollover into which offer overnight switching. I have an AustralianSuper fund which will allocate to a different option the next business day if you put the request in before 4pm. And it shows up as such the day after that. There is also an option in that Superfund to manage shares in the ASX300 as well as select ETFs for immediate buy/sell. I do likewise in an ING Superfund - which offers even more choice in terms of a large list ETFs alongside the ASX300 stocks. The buys/sells are live in the market. It allows immense control over your Super. But the ING fund is poor for option switching, can take a week. If you just want to do that, AustralianSuper is overnight - but I'm sure there are many others similar as well. Investigate, rollover. Good luck.
Rudi - great article, mandatory reading for investors of all levels of experience. I expect the terminology will be little different once we get back to some level of normality; eg, expect the '.....green shoots of recovery......' to make a comeback, but let's hope there isn't a lawn mower to flatten them for a while once they appear.
Excellent article, whether the market rallies from here or plummets, the factors and considerations are well thought out and presented. Definitely a quality piece of logical and insightful work that supports all investor financial strategies. Well done Rudi and keep them coming. Between you, Jerome Lander and a couple of others, you are head and shoulders above the fundies pedalling their wares.
The big end of town wins and small investors loose - again. I am saddened but not surprised that intuitional raisings at fire sale prices from which shareholders are excluded have become common. Our regulators for whatever reason are loosening the rules with little regard for existing and smaller investors. Unintended or maybe intended consequences? Geoff W