Five rules for investing during the coronavirus outbreak
By Justin Thomson, chief investment officer at T. Rowe Price
Crises are a fact of life in financial markets. Over the past 30 years alone, we have witnessed the early 1990s recession, the Asian financial crisis in 1997, the collapse of Long‑Term Capital Management, the 2008-09 global financial crisis and the 2011-12 European sovereign debt crisis. Each of these crises was different, but there were also common threads. As investors, what can we learn from prior events to help us navigate the coronavirus pandemic?
The current situation is particularly challenging because it is not just an economic crisis, but also involves health and welfare. Governments are treading a fine line between avoiding an economic meltdown and trying to prevent health care systems from being overwhelmed.
This crisis is also unusual because it is so acute. The descent from a record high of the S&P 500 Index to bear market territory was extraordinarily swift and brutal. Further complicating the situation is the fact the coronavirus has delivered an enormous, but as yet unquantifiable, dual demand and supply‑side shock – with shortages of labour and medical supplies on the one hand and an excess supply of oil on the other. It is clearly a deeply worrying time.
Lessons from the past
What common threads of previous crises can we see in the present one? The process of de‑risking has brought us the familiar pattern of sell‑at‑any‑cost, disorderly markets and a breakdown in typically expected asset prices and correlation. At the individual stock level, the mechanism of price discovery simply breaks down. This is both a source of frustration to investors, who cannot understand what they got wrong, and an opportunity, as genuine mispricing occurs. Above all, we are being reminded that bear markets are intellectually and emotionally draining.
With all of this in mind, here are five suggestions to help investors survive and ultimately thrive during this difficult period.
1. Be patient. Do not try to solve for the whole world at once. In crisis markets, it is natural to look at your entire portfolio or coverage list at once and think getting market direction right is the only thing that matters. This is incorrect. The better you understand your companies, the more confidence you will have investing into air pockets. These moves should ultimately be rewarded when we get to the other side. Stay focused and break your workflow into manageable bites.
2. Avoid predictions. You cannot pick the bottom, so why beat yourself up. It is easy to start the day with optimism and get stuck in the market only to look foolish by mid-afternoon. Nobody, no matter what they claim, has the power of precognition – so avoid becoming obsessed with it.
3. Stay invested. Keep embracing risk and remain allocated. When the reversal comes, we believe it will be powerful, and the majority of the potential upside will come in a limited number of sessions, so you will not be able to get invested in time. In the bear market cycles previously mentioned, the inflection points only became apparent with the passage of time. No bell is ever rung to signify the bottom.
4. Monitor quality. Do not get anchored to the points prices have fallen from. In security selection, we are always making a relative bet, but I recall from 2009 it was ‘quality’ bouncing hardest. The exercise is now one of selling low to buy low. Quality stocks now offer enough potential upside you do not need to take existential risk with leveraged balance sheets.
5. Be alert for fallen angels. For small‑cap or high yield, the other pattern I remember from the 2008-09 crisis was the fall of economically quite large and/or highly rated companies into small‑cap or junk territory. These companies can present both opportunities and sources of index risk. After the global financial crisis, many soon recovered mid-cap or even large‑cap status.
So far, so tactical. But it is also important to be strategic. A new cycle is being set, so there will be new trends and new market leadership. At this point, it is impossible to identify all of those trends, but at the very least, we appear to be in a new era of fiscal expansion.
Finally, I should emphasise that truly great companies are rare. A 2016 study by Hendrik Bessembinder at Arizona State University, for example, found from 1926 through 2015, just 86 stocks out of 26,000 examined accounted for 50% of the market’s return. The top 1,000 companies – less than 4% of the total – accounted for 100% of the wealth creation during that time. Opportunities to buy great companies at great prices are even rarer. We are currently at one of those moments.