Where are the best opportunities right now?
At what point do you think it’s time to start buying individual stocks?
Where are the deals?
I get questions about individual stocks (and the companies behind them) every day. Common inquiries usually involve behemoths like Apple, Tesla and Netflix. These days, even my conservative clients are asking about big dividend payers like Exxon, Coca-Cola and Pfizer.
Truth be told, I’ve never been much of a 'stock jockey' (someone who prefers investing in individual companies over diversified instruments like funds, and sometimes trades frequently). Actually, that's not entirely true. I did dabble in stocks for a while while I was in college. Not surprisingly, it ended badly, as it does for most people who try. From that point on and throughout my professional career as a financial advisor, I have slowly gravitated more toward low-cost, no-load actively-managed funds by some of the largest money-managers in the industry, like Vanguard, T Rowe Price, Fidelity and others.
There are times someone will question my strategy, but that's rare- especially during and after volatile markets. That's when most people realize that trying to beat the market by picking the 'winning horse' can be exciting and sometimes rewarding in the short-term, but is a very difficult game to succeed at long-term. That doesn't stop scores of investors each year from stepping into the ring to try their hand at fortune-teller in an irrational market. Wall Street, like Las Vegas and carnies across the land, love them for it. I sometimes wonder whether the appeal of games of chance may be wired into our human DNA.
The primary appeal of stock-picking over the last few years is that the market just kept going up, almost without fail. Until recently, most were selling at a historical premium, fueled largely by monetary and fiscal policy, as well as other forms of financial engineering like stock buy-backs.
However, everything in the universe exists in a cycle and we are seeing many stocks return from the stratosphere for the first time in several years. As a result, our office has begun to work more closely with some clients to identify and evaluate individual companies and specific sectors that might become especially attractive during this period of chaos. The primary impetus is simple: we suspect some "babies have been thrown out with the bathwater." Here's the the method behind our madness...
In the 21st century, hundreds of millions of investors have become increasingly intoxicated by the allure of Exchange Traded Funds (ETFs), instruments that typically allocate their portfolio across many investments (similar to mutual funds) but which trade like stocks. This means that unlike mutual funds; ETFs can be bought, sold, and fluctuate in price throughout the day without investors having to wait until the end of the trading day to know what they are worth. They've exploded in popularity and expanded in breadth- today an ETF is available for virtually every investor predilection one can imagine- from certain regions and countries, to specific industries and themes.
Perhaps their most competitive advantage is that they are often ultra-low cost, owing to the fact that most are passively-managed, meaning holdings are bought and sold each day by robots, computers and other forms of artificial-intelligence (A.I.), based on algorithms and computer programs designed by humans to trade off a specific strategy and employing special filters. For instance, an ESG (environmental/social/governance) ETF might only invest in companies that adhere to a specific mandate to protect the environment, minority rights or some other social justice cause. SPY, one of the world's most popular ETFs, simply holds a portfolio that exactly replicates the S&P 500. There are ETFs for health care (XLV), cannabis (MJ) and even pigs and cows (COW). Yes, really!
Growth in the ETF sector is arguably one of the most disruptive trends in all of global finance this century. Instead of attempting to beat market returns with investments hand-picked by professional money managers in actively-traded funds (which is extremely difficult to do, especially in a market rising consistently over long periods), ETFs instead attempt to simply keep pace with returns of their specific market segments. This strategy might hold weight considering the plenitude of studies showing only about 50% of actively-traded mutual funds ever beat their benchmarks.
As almost all markets have continued to climb unabated since the GFC (Great Financial Crisis), more and more investors have abandoned their actively-managed mutual funds (guided by expensive humans) for virtually "free" ETFs because- all things considered- in a market where everything has only gone up for over a decade, people have failed to see the value of compensating humans to make individual buy and sell decisions. Why pay a high-priced money manager in NYC when you can simply "buy it (the index) and forget it"- i.e. just ride the central-bank-backed 'everything wave?' It's the same argument that has done in travel agents, bank tellers and other professions swallowed up by massive computer power and the simultaneous Internet and Information Revolutions.
The answer, of course, is because there is no such thing as a free lunch. While most investors have failed to grasp it, when you transfer your assets from actively-managed to passively managed, you in effect become your own money manager. That works when the market seems to only go up, and it can also work if you have a money manager on your side that you can trust to guide you and manage your portfolio of ETFs. But it can prove disastrous for the individual investor in times of market volatility or even turmoil.
Markets can be brutal and unforgiving. And most people are unskilled with money in general, not to mention the financial markets, as we've discovered in 2020. Barely 60% of the country could cover a $1K emergency and average household credit card debt hovers near $10K most years. That's one reason our own Federal Reserve and Congress has been so swift with their policies to backstop a nation of over-leveraged, over-stretched and overly-entitled consumers. The idea that making money in the stock market is easy and requires no training or skill is a new one in the scope of financial history. Without the ability for our leaders to print money without consequence, it's easy to see how painful this last quarter could have been.
It's only since the advent of ETFs at the turn of this century- along with the sudden mass affluence of the Baby Boomer generation (starting in the 90's and peaking in the current era) and the super-charged engagement of a global cabal of central banks all marching in unison with predetermined outcomes- that individual ('retail') investors began to see themselves (consciously or unconsciously) as their own private money managers.
That has all come into clear focus this past quarter, as we saw historic market swings at paces that are unprecedented. Today, as opposed to past market corrections, investors have multiple cable networks devoted just to the stock market, along with the ability to track their holdings every second of every day on their mobile devices. But most importantly, they have access to their own accounts and can trade them unimpeded by the obstacles of the past (commissions, brokers, lack of information, manual trading, etc.) This article does not serve to argue for and against these instruments- which are truly remarkable innovations in their own right- only to condense the brief evolution of the Exchange Traded Fund for the purposes of explaining why stocks might now be appealing.
Hang in there, we're almost done.
As a result, ETF investors have enjoyed many years of what seemed like ‘easy money’ DIY (do-it-yourself) investing. Just put your money in the market and ride it up, seemed the mantra. Not surprisingly, funds managed by humans have fallen largely out of favor because humans and research are high-cost, like in most businesses. Now that lack of professional management is being seen as a challenge instead of a benefit, as many ETFs that rose with the markets are now experiencing the downside of that strategy the last few months. What was once a strength has now become a weakness.
In my estimation, that’s could be a significant factor in both the breadth and depth of our recent drops- i.e. millions of uneducated and more importantly, undisciplined investors guided by their emotions, watching (in some cases) CNBC as well as their life savings dropping. So they simply open their smartphone app and press "sell" in their 401ks, IRAs and investment accounts at their online discount brokers.
Through conversation, I've discovered many who did this never really understood the process they were involved in - that someone else was on the other end of that trade and probably had more information, experience and skill then them. These retail investors who sold out in March repeated one of the most common mistakes in investing: they transferred their wealth to someone more knowledgeable and patient. (They also believed what they were told by the media and experts, unaware they were being purposely conditioned and manipulated to sell... but that's an article for another day!)
A Case for Stocks
This phenomenon happens in every market cycle- and not just stocks! It’s also reasonable to assume we’re not done in this cycle- in my experience, it’s not until the most disciplined retail investors consider throwing in the towel (what we term ‘capitulation') that’s we’ve hit rock-bottom and can begin the deceptively long and steady climb up into the next big bull market.
What this also means is that all those passive funds rode the market down because they had to. There are no humans managing those funds, only computers. And those computers make no distinction between good companies and bad companies, overvalued vs. undervalued. They just sell, which begets more selling by the next fund, and on and on we go down the abyss. If selling causes the S&P 500 to drop, then SPY has to sell in the exact proportion to maintain its mandate. It has no choice. It doesn't ask who, what, where, when and why? It does what its programmers told it to do. And often generates a spiral in either direction.
If an ETF must sell quality companies to do so, no one is there to tell them otherwise. In fact, most times it is forced to sell the best holdings because those are the components not moving in lock step with the market, creating an odd-dynamic of selling quality to buy junk. That should give any investor pause. It's not looking around for bargain-basement prices, forgotten companies or good companies in a bad sector. If that sector falters, the ETF representing it must sell, too. And did you know that many ETFs literally trade depending on the words in news article headlines and Bloomberg terminals? For instance, one might sell if it exceeds its quota for the word "sell," or "misery" or "losses." If you think that is insane, welcome to modern financial markets.
As a result, what might have been a 5% correction a generation ago when the market was mostly run by humans might now result in a 30% correction. Today is a market environment in which over 70% of trading is done by computers, and that percentage increases almost every year. This behavior - whether it be buying or selling, stocks or options, calls or puts - often continues until some force- usually those 'expensive' professional investors with deep pockets, more experience and longer time horizons, as well as ‘actively managed’ mutual funds led by actual humans (think Warren Buffett and Blackrock in 2008-09), step into the selling void and start buying what they believe feels like a market or sector that they perceive is 'on sale.'
Where to Start
Many great companies were sold off in the most recent market rout, and some remain down to this day- "babies thrown out with the bathwater." I'm prohibited from suggested which ones are in print, but perhaps you can think of a few...
Which of these companies do you suspect will survive COVID and still be in business 3/5/10 years from now?
What companies might slow their growth but still gobble up market share during this correction?
Which companies might be well-positioned for the country and world that emerge from this crisis?
If you're uncertain of this, then I suggest contacting a trusted advisor or even non-professional financial counsel and visiting with them. Or partner with a strong actively-managed mutual fund. Or you can even call me if you are really desperate- I'm always happy to point you in the right direction, even if it's not mine.
The truth is that investors will have a plethora of options to protect and grow their portfolios in the months to come, and some deals are already available. For a lot of new money coming in to my office (and there is more coming in than going out ), my overriding recommendation is to be patient. Set up an account (if you don't have one), make a contribution you can afford and then put it into a reliable, liquid money-market-type fund. Then wait for the following to become clearer:
What will the unemployment situation look like in a month or two?
How effective will fiscal and monetary policy be at ending or even reversing a recession?
When will we formally and honestly address the sensitive conversation of when to allow the country back to work?
What happens if some investors who forgot to establish 3-6 month emergency funds in the past feel compelled to liquidate their investments now?
Will they be forced (or coerced) into trading some of their quality investments for cash... "not because they want to, but because they have to?"
Which companies would you love to be an owner of for the next 10+ years?
And what is a fair price for that company?
I'm no pandemic expert, but I suspect we will have a much clearer picture of the health and economic impacts of our current crisis in the next 30-60 days. I think that cooler heads will prevail at the state and local level and more enlightened responses will replace some of the rushed, arrogant and power-mad decision-making we've witnessed thus far. I anticipate having more and better data from other countries that were affected earlier than us.
In short, I think we have more time than we think.
I could be wrong, and often am. Maybe we're only in the early innings of a larger sell-off. Or perhaps we are already be climbing out of the morass- last month certainly provided some hope this could be the case. In addition, Wall St. tends to think (and react) by looking out about 6-12 months and so big gains that some might feel are unjustified today, may simply be manifesting now because people are trying to get a good seat in the stadium before the game truly starts. They're happy to camp out in the stands for a little while. They know that's how the game has been played for a few hundred years.
It's always useful to remember that the S&P 500 (the index many use to gauge the US market) hit a cyclical bottom in March of 2009. This was when Treasury Secretary Hank Paulson famously got on a knee and begged Nancy Pelosi for $700B, a number that seems almost quaint today! Most people forget that the S&P rose 23% that year. It was a scary time until it wasn't.
Many investors I’ve met since then who got out at some point during the drop never truly got back in until sometime around 2010 or 2011 at the earliest. Plenty waited much longer and missed the majority of the low-hanging fruit. Others are still waiting to get back in. But almost all of us missed a portion of the largest and longest bull market in our country's history.
All bets are off of where we go from here and at what pace. But I am doing my best to encourage my clients to consider the famous stock market adage: "Don't just [do something], [sit there!]" And if they do have some 'lazy money,' I encourage them to simply begin thinking about what they would need to see to believe the economy and stock market are not irrevocably destroyed and what opportunities may exist on the other side of this human and financial tragedy. I suspect when you reflect on that, it's a lot less improbable than most people think.