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.

Chaos And Hope

By now, the damage of the coronavirus pandemic must be obvious: stocks have fallen almost daily. Again, CNBC revealed this was the fastest 30% sell-off ever, exceeding even the Great Depression.

However, for investors who are adhering to asset allocation (strategic or tactical) using broad base quality index funds, stocks are becoming more attractive. In the time of this great chaos, we want to offer some calm suggestions.

First off, let’s review markets a bit. We believe that, even for those whose investments aren’t affected,  current market behavior offers a very good ‘live’ lesson to learn things that are usually viewed as ‘extremes’ in many financial models or popular theories (though in reality, they aren’t that extreme at all).

Chaos in bonds, money markets and ETFs

The fast and violent development of the pandemic has caused upheavals of supposedly ‘safe’ bond markets. The following chart compares several Vanguard index mutual funds:

VFITX: Intermediate Treasury, VFICX: Intermediate Term Investment Grade Corp Bonds, VWIUX: Intermediate Term Municipal Bonds, VBMFX: Total Bond Market Index

Other than Treasury bond fund VFITX, all other reasonably safe bond mutual funds lost money since the end of February. In fact, even VFITX lost money in a few days last week. The ‘good’ municipal bond index fund VWIUX lost a whopping -10% while the investment grade bond fund VFICX lost almost -8%. This was not really surprising as we have stated several times that investment grade bonds are likely to suffer in the next downturn. It’s just the speed that this happened is unprecedented. Well, this definitely has a feel of a crisis, similar to that in 2008-2009.

On the other hand, even prime money market funds had shown some signs of ‘breaking a buck’: meaning its price might drop below $1, or investors will lose money. Fortunately, Federal Reserve and some firms stepped up this time early to stabilize this (see this and this)

Note that only prime money market funds had trouble. We take an interest to see what happened to Federal and Treasury money market funds and so far, they have done well. Interested readers are referred to our previous newsletter February 4, 2019: Cash And Money Market Funds: Interests And Safety for more detailed discussions on safety and types of money market funds. Again, we believe that even without FDIC insurance, Treasury money market mutual funds are as safe as bank savings. But on the other hand, prime money market funds, as shown recently and in 2008, do have danger of losing money.

Unfortunately, this is not the case for all ETFs. Let’s start from ‘money market’ ETFs. In our previous newsletter August 27, 2018: Money Market ETFs? , we stated that so called ‘money market’ substitute ETFs aren’t safe. This is what has happened so far in this crisis:

NEAR (iShares Short Maturity Bond) was once touted as a substitute for a prime money market fund. It lost over -9%! What’s more, remember the so called Money Market ETF Portfolio (was promoted by Betterment for a period of time) that consists of the following:

UltrashortTreasury SHV 80%
UltrashortBonds NEAR 20%

It unfortunately couldn’t pass the money market safety test, losing -1.3% at one point.

This is certainly not acceptable if you need to withdraw from such a ‘money market’ account right now.

Moving on to ETFs, we are still seeing some big dislocation in high yield municipal bond ETFs and corporate bond ETFs. For example, as of this writing (3/23/2020), VanEck High Yield Muni Index Fund HYD has a huge -20.29% discount against its NAV:

Interestingly, Vanguard Interm Corp Bond index ETF VCIT overshot today (3/23/2020), now it’s slightly overpriced than its NAV, eliminating its almost -5% discount in the previous week:

Again, times like this offer a rare live opportunity to learn things that are often unthinkable can happen.

Be optimistic

Although it’s gut wrenching to see daily drops in your stock (and even bond) holdings,  we believe we are actually approaching some more reasonable valuation levels for stocks. At 2220 or so, S&P 500 index is now priced to be at about 20 times price over 2020 estimated earnings ratio, using Goldman Sachs’ $110 Earnings Per Share (EPS) for S&P 500 companies (Goldman Sachs is the most pessimistic one on S&P 500 2020 earnings estimate so far, though we suspect more downward revisions from other firms will come). This is certainly not a bargain. However, compared with the historical record ultra low 10 year Treasury bond yield at 0.8%, the earnings yield 5% (1/20) is actually not bad at all.

It has been said that S&P 500 might fall to 1500 or so (see, for example, this article).  Regardlessly, we want to offer some optimistic suggestions, for both those who are holding diversified stock index funds like SPY/VTI or for those who have new money to invest:

  • If you are holding an S&P 500 index fund like SPY, VOO or similar diversified fund, remember what we said last time (April 1, 2019: S&P 500 As A Business), you are essentially holding a conglomerate ‘business’ that hasn’t lost money in any single year since 1871. Furthermore, as long as the capital/financial market is not totally destroyed/collapsing and is still governed by rule of laws, (partial) equity owners or shareholders will be rewarded with inflation beating returns in a long period of time (again, as we stated before, 20 years or longer), in fact, with almost 100% certainty.
  • At the moment, with deflation pressure and central banks’ aggressive monetary policies, as long as long term Treasury yields stay low, a PE ratio of 20 or lower (thus earnings yield 5% or higher) offers some reasonable valuation. Of course, it’s likely stock indexes like S&P 500 will lose some more (such as 20% or 30%), but at this level, we believe fund holders will be able to get reasonable 3%-5% annual returns in the coming decade.
  • As long as you don’t need to use this money in short term (like tomorrow, in a month or in 2 or 3 years), you will likely not do worse than the current level. So there is really no need to panic.
  • For those who have new money and would are itching to do something, you can start to nibble/dollar cost average into the stocks.
  • However, the above discussion is all based on the premise of investing in a high quality index fund like S&P 500. Though you might likely get higher returns by investing in some individual stocks, remember the risk of losing money in individual stocks increases dramatically (unlike in our S&P 500 solid conglomerate). In fact, it’s much certain even in a long period of time you can make reasonable returns. So tread water accordingly.
  • Finally, for those who are holding money ‘losing’ bond funds like VCIT, we believe things will get stabilized as both the Federal Reserve and government have worked hard to support bond markets.

To summarize, though current crisis is unfolding like how we described in our previous newsletters, we believe stock markets are becoming safer. Though this is still not a level to pound the table to buy, it’s also not a level to be panic at all.

Market overview

The following chart compares last week’s returns of several stock indexes:

Some observations:

  • Both EFA and EEM (international and emerging market stocks) lost less than SPY. This happened even when US dollar was strong. This indicates that foreign stock loss has slowed down a bit (as they began with much lower valuation than the US stocks).
  • Utility stocks (XLU) now caught up with general market. This usually signals a serious crisis.
  • On the other hand, IWM (small cap stocks) are now in par with SPY, indicating we are probably at a stage where stock loss will pause a bit.

Again, as indicated, markets will likely experience further loss and/or big gyration in the coming months.

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.

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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