Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Wednesday April 1, 2020.

Please note: As of March 1, 2020, we officially phased out our old rebalance calendar for both SAA and TAA. They are now always rebalanced on the first trading day of a month. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

A Live Lesson

Financial markets are now in a total panicking mode. CNBC put out the following chart on last Friday:

Then, after today’s market close, it put out this chart

To say that current stock markets are devastating is not an understatement. 

However how much the current condition affects us personally, we actually think this is a rare opportunity for us to understand market extremes and market prognosis and what to do or not to do in our investment portfolios. 

Out of whack markets

In addition to charts like the above and your investment account numbers, the following market anecdotes tell us the current markets are out of whack, or investors have acted out of great fear so far in some irrational ways. 

  • Big discount against NAV (net asset value) for some ETFs. The NAV of an ETF is just the actual value of its underlying holdings. In today’s close price, HYD (VanEck Vectors High Yield Muni ETF) is priced at $50.40, while its NAV is $60.78, a whopping 17% discount. What this really means is that market operators cannot easily or are not willing to arbitrage by buying the ETF and then redeem for its underlying individual muni bond holdings and then sell them in the bond market. This can happen because of the fear of fast movement or change of muni bond prices. This is a lesson for ETF investors: for some high yield muni or corporate junk bond ETFs, some big discounts can happen in a desperate out of order market. In fact, HYG and JNK, two high yield corporate bond ETFs had even larger discounts in the 2008 crisis. 
  • Unfortunately, it even started to show a similar discount pattern for investment grade bond ETFs such as VCIT (Vanguard credit bond fund). VCIT currently has  1.1% discount against its NAV but at some point last week it had 4% or so discount. 
  • Even gold (ETF GLD) has been down for the past five days. Gold is regarded to be a hedge against a crisis exactly like the current one; a deflationary and uncertain situation. Unfortunately, just like Treasury bonds, these safe havens were sold as traders/speculators were forced to sell even ‘safe’ holdings to raise cash for margin and other reasons. 
  • Some so called ‘safe’ funds such as risk parity funds are also hit hard. For example, Wealthfront Risk Parity Fund (WFRPX) has been down almost -26% year to date, compared with AQR Risk Parity Fund (AQRIX)’s -10% YTD drop. Risk parity funds are supposed to have risk somewhat at most comparable with a 60% stocks/40% bonds balanced fund. This shows how volatile and sensitive the current market is: a small implementation difference can make a huge difference. 
  • Some big reputable hedge funds were caught flat-footed: Bridgewater Pure Alpha fund has lost more than -20% year to date as of last Thursday. This is a very reputable fund. We suspect there will be more similar surprises as time goes. 

What we can learn from the above is that in a distressed market, ‘Anything that can go wrong will go wrong!’, Murphy’s law. So to be successful, investors must be rigorous to stick to some easy to implement and less error-prone strategies. We’ll come back to this topic later. 

Covid-19 pandemic: what’s the end game?

Again, we don’t profess to be an expert in this topic. But even as an ordinary citizen, with reasonably credible information and some logical reasoning, we usually can make some good educated guess, just as what we did in our previous newsletter March 2, 2020: The Risk Of Coronavirus Outbreak  and the most recent one March 9, 2020: Risk And Reward

In fact, in the previous newsletter, we stated: 

This process is distinct as it will drag on for a while with daily bad news continuously reported for a while. One can see what happened in the past one plus month in China: bad news first surfaced and then more bad news pile up. Unlike China, the US and Europe are probably adopting less draconian containment measures which in turn will prolong this bad news process for a while. A reasonable guess is that it probably will take at least a month or two to reach a pivot or turning point. 

As more bad cases and news coming, consumers and companies will adopt more stringent measures for safety. Some of these can be overshoot (just as in any other situations) and some of these can be amplified by news, causing panic. So one can expect that the economy activities will be seriously affected in this first phase. As the financial impact of these measures usually lags behind, one will see more bad economic and financial news will be reported in the coming several months. 

What happened in the last two weeks was exactly like what we described in the above. But we want to dig in a little farther and forward. As an investor, we want to ask ourselves: what’s the end game for this pandemic and our current efforts?

To answer this question, let’s formulate the likely path of this pandemic:

  1. Phase 1: waking up to face the reality. In this phase, governments/authorities start from complacency/hope for the best attitude and then finally wake up to the fact that the virus has been here firmly and the number of affected cases will grow/has grown exponentially. We believe the US and most European countries have passed this phase. 
  2. Phase 2: containment/suppression. Authorities try to slow down and suppress number of affected cases so that health care systems are not overwhelmed and even collapse. The society, however how inertia and complacent it is, cannot accept to see their loved ones die in large numbers in a number of days (just like what happens now in Italy and what happened several weeks ago in China). Thus authorities are forced to act/react in this phase and start to adopt more stringent measures including social distancing (work/stay at home), closing down social related businesses (travel, sports, live entertainment etc.). The US and several European countries just began this phase. 
  3. Phase 3: Declining number of affected cases till it’s somewhat stabilized, either reaching 0 or close to 0 or in some flat number. China is now in this phase. 
  4. Phase 4,5…: Now what?

Note that countries might adopt various measures in phase 2 and phase 3. Some of them will strive to suppress the number of affected cases to zero (at least hope) and others might give up hope to totally suppress this virus, instead they adopt slowing down/smoothing out policies. Either way, they all try to reach certain stable conditions. 

We have no doubt that we’ll be able to get to Phase 4. At the end of the day, with all of the efforts now countries are making, we believe, based on Italy and South Korea experience (the two extreme models that are more close to western societies), things will be able to stabilize and then we will exit Phase 3 in 2 or 3 months. The key question then is now what?

Of course, the ultimate end goal here is to eradicate this virus all together or at least make it only affect very few people. The best hope here is through vaccination. Unfortunately, based on various reports, the earliest time a vaccine can be developed, validated and used in a broad population is a year or so away, based on various medical experts like Dr. Anthony Fauci, a director in CDC. So what’ll happen after phase 3? 

In the best scenario, after phase 3, all countries might be able to totally suppress the number of the affected cases to 0, meaning the virus is totally eradicated/disappear for good. But based on how wide spread this is now in the world, we highly doubt that’ll be the case. In fact, it’s highly unlikely (but still possible) that the virus will completely disappear in 2 to 3 months even in advanced western countries. 

It’s more likely that in phase 4, countries now have the containment/suppression/tracking process in place (developed in phase 2 and 3) and now they can be more effective to control small outbreaks. Furthermore, as most developed countries are in the northern hemisphere and once we enter summer, the outbreak will be much easier to control. It’s important to see here the importance of the process/mechanism/measures developed in phase 2 and 3. These measures/practices might include the following: public/businesses will accept some sort of measures such as privacy breaking tracking (for at least certain cases), some various degrees of social distancing etc. These measures learned previously will help to quickly suppress/control small outbreaks (even when winter comes, for example). Hopefully, this will carry us to the time when a vaccine is deployed, or an effective cure is developed, or the virus just disappears by itself. 

Other than the best scenario where the virus is eradicated in 2 to 3 months, we can see that economy will meander through phase 4 or other phases with some constraints or restrictions. It might even fundamentally or structurally change some of our practices (such as globalization/supply chain etc.). Unfortunately, any such changes will take time and they have some very meaningful impact on the economy and financial markets.

The above reasoning by no means is complete. But that will give us some reasonable educated guesses: in the most likely situations, it will take time for the economy and thus financial markets to recover. Furthermore, as stocks were in very overvalued condition when this crisis began, it’s hard to imagine markets will quickly recover back to the previous level. 

What to do

Based on the above analysis and the current market conditions, we want to offer the following comments: 

  • For those who follow our tactical strategies such as Asset Allocation Composite (AAC)  or Tactical Asset Allocation(TAA)  rigorously, congratulation! At the moment, it at least looks like you have avoided some large loss by exiting stocks and moving to bonds in time. For those who haven’t carried out rebalance because of various reasons, it might be too late to sell in such a depressive level. You can either rebalance when stocks recover to a level you are comfortable (but probably very unlikely to some previous high levels in short time) and then follow back the strategy, or you might just have to sit out this storm. 
  • For those who follow Strategic Asset Allocation (SAA) (buy and hold) portfolios, as stated in the previous newsletter, you should sit tight. Right now, this is the worst time to panic and liquidate. 

Finally, for AAC/TAA investors and SAA investors with new cash, the more markets drop, the more excited and ready you should get. Just like in the above analysis, in an out of whack market, lots of quality companies or bonds are on sale. Of course, as markets are still in aggregate not very cheap: at the current 2500 level, S&P 500 will probably return 2-5% annually in the coming decade, for AAC/TAA investors, you should stick to the strategies till they signal buying stocks again. For SAA investors with new money, a DCA (dollar cost averaging) approach is a good way to slowly purchase more equities (of course, only to your target allocation). 

Market overview

In times like this, our boiler plate suggestion is the following (just like in the last newsletter): 

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or longer. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Finally, as markets are getting more and more reasonably priced (or cheap), there will be good opportunities to take more ‘risky’ exposure  in stocks (in fact, a good diversified stock index fund like S&P 500 becomes less risky and even safe when markets are cheap enough). So in a sense, the current market loss is actually the beginning of a good investment opportunity. This is what a good investment strategy is all about.

For more detailed current market trends, please refer to 360° Market Overview.

In terms of investments, stocks are finally getting cheaper. Investors should not be swayed by the current market volatility and economic distress, instead, they should stand ready to take advantage of the opportunities. For most Americans, we offer the following Winston Churchill’s remark made in the darkest days of World War II: “The Americans will always do the right thing, but only after they have tried everything else.” As a country, the US (and the rest of the world) will get over this, as always, even after stumbles. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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