Jul 30, 2020

What's New With Investing - 2020

This update is dominated by the impact Covid-19 has had on the investing this year.

 

Why is the stock market, after initial chaos at the beginning of the pandemic, not reflecting the downturn in the economy? What should investors consider in terms of diversifying, rebalancing, and retirement savings? And what about gold?

 

The NYSE president explained at the end of May that the “market” as represented by the S&P 500 or Dow Jones Industrial Index is a) forward looking and b) doesn’t reflect what is happening for the rest of the companies trading in the market (smaller than those in the index). (Marketplace: 4 minute audio)  And Visual Capitalist has a great infographic that demonstrates the disconnect between consumers and the stock market.

Even today, when a record 33% annualized drop in GDP was announced, the markets closed lower, but not by much.  Some of that may be because the market EXPECTED a drop of 35%.  It is more about the deviation from expectations, which are already factored in, than to the numbers themselves. (CNBC)

One month after that interview, at the end of June, the indices started to diverge—with tech stocks (NASDAQ) doing well, and blue chip stocks (DJIA) not doing as well. The composition of these indices tells the story. WSJ-(subscription). Specifically, Ed Yardini’s blog post looks at the FAANGM stocks (Facebook, Apple, Amazon, Netflix, Alphabet, and Microsoft). As of the beginning of July, all but Netflix held the top five spots in terms of market capitalization for the S&P 500. Their combined value made up 25% of the total S&P 500 value, up from 8% in 2013. When you think about it, all of these stocks are weathering the pandemic just fine, if not thriving.

So what other stocks have weathered the COVID storm fairly well? Apparently, those that are ESG oriented. ESG stands for environmental, social, and governance (ESG), according to a report by Bank of America.

“ESG is a bear market necessity, not a bull market luxury,” the report concluded. Lately, it said, exchanged-traded funds (ETFs) overall have been hit by outflows, but ESG-oriented funds have had inflows.

Credit those better returns. ESG has outperformed by 5 to 10 percentage points in in the US and Europe since the stock market peak in mid-February, versus stocks with lower ESG scores, BofA found. The “S” is the biggest reason for that here.

At the end of June, the S&P 500 was off 4.7% for the year, and the Visual Capitalist published a chart of historical stock market returns (200 years!) to demonstrate the drop was well within historical experience. The graphic here is very powerful!

As happened in 2008, many investors did panic and sold stocks when they dropped so precipitously in the early days of the pandemic. Behavioral scientist Shlomo Benartzi explained why this is so in early April for the WSJ. It’s referred to as “myopic loss aversion.” We all have loss aversion to some extent. But when taken to an extreme, people have trouble looking beyond their most recent experience. They see their wealth drop, can’t take it, and sell, missing out on investment returns. If folks held on through the first quarter drops this year, they were rewarded with quarterly returns not seen in decades for the second quarter of 2020. (MarketWatch)

Author and WSJ journalist Jason Zweig offers more assurances if faced with a bear market. In his blog entitled “Stop Worrying and Learn to Love the Bear,” he suggests that in fact, a bear market is a great opportunity to “buy low,” and enjoy the coming years as the value of your portfolio grows. Warren Buffet would agree. (see below) When the stock of a company he owns drops 50%, he is thrilled that he can buy more, because if he decided the company was a good investment, nothing has fundamentally changed. So, if you were able to buy into an index fund when they bottomed out around March 23 (when the DJIA dropped below 19,000), you would be up a whopping 42% as of yesterday!

But scary times and panic are never good reasons for selling out of your stocks.” The Fortune article from which I took this quote attempts to address the situations when it might reasonable to see stocks in this uncertain market. The focus of the article is for investors nearing retirement.

  1. When it is time to rebalance your asset allocation. The timing will never be perfect, so stick to your allocation targets and don’t try to time it.
  2. If you need to diversity. As you approach retirement, you move from accumulation to distribution, and may need to move some of your equity into fixed income investments to avoid the possibility of having to sell stocks at a loss when you need to make a required withdrawal.
  3. If your investment strategy bombed out. Cut your losses and run.
  4. If you have amassed 20-25 times your annual needs, you can cash out and not worry about it anymore!
  5. If you have had a major change in your circumstances, time horizon, or risk profile.

A Q&A between Michelle Singletary of the Washington Post and Christine Benz, director of personal finance for Morningstar addresses many questions from retirees and soon to be retirees about their 401ks. Along the lines of these other articles, it stresses the need to maintain stock in your 401k and not to panic. Among other reasons, one big reason is that equity is a hedge against inflation, which will eat up your portfolio if you cash out all of it now. Even online savings accounts are only paying 1%.

 

With a volatile market and low interest rates, gold is getting renewed attention. Of Dollars and Data explains why gold is valuable. (Alternatively, you can watch the TWO CENTS explanation.)  It is definitely worth a few minutes to learn the history of gold and learn why it has any value at all. Bottom line on the gold story is that as a stand alone investment, it ends up being more volatile than the stock market, and depending on the time period, (it has never surpassed its 2011 peak value), has a lower return. The value of gold as an asset is as part of a diversified portfolio, as it often does well when the other asset classes don’t. (Of Dollars and Data demonstrates this well.)

  

What is behind the HUGE increase in retail (individual) investing in the stock market (day trading and derivatives)?

Initially, it looked like it might be that gamblers turned from sports and casinos to the stock market and day trading during the lockdown. (CNBC) But the surge in individual investors trading stocks started even before the pandemic. The major online brokers — Charles SchwabTD AmeritradeEtrade and Robinhood — saw new accounts grow by 58%, 149%, nad 169% in the first quarter over the previous year, respectively. This was a quarter when stocks experienced the fastest bear market and the worst first quarter in history. (CNBC1)

Robinhood got lots of attention during this same time period. (WAPO). Robinhood has been credited with the “democratizing of investing,” making investing accessible to the masses with no minimums or commissions. Other retail brokerages had to follow suit, at least on the no commission front. (Robinhood also took lots of heat when their platform couldn’t handle the volume during more than one of the most volatile trading days early in the pandemic.)

Schwab has come up with its new “slices” program, which allows customers to purchase dollar amounts of shares, rather than whole shares of a particular stock. This is Schwab’s attempt to lure younger clients, to compete with Robinhood (Financial Planning). Fidelity, on the other hand, has launched a mobile app with lots of educational components to attract younger investors. (Investor News)

Of course, as more people get into trading, it is inevitable that some will get in over their heads, often with disastrous outcomes. This is particularly true as they move from trading stocks to trading options. (WSJ) (NYTimes) According to Options Clearing Corp. data, the average daily number of options traded jumped 45% from last year to a record 28 million. A record 14% of those trades were single options contracts (individuals, not institutional trades.) Robinhood has particularly loose “guardrails” on its options trading. In order to open an options account, you must answer a questionnaire. As educators, we know that young folks are quite comfortable trying again until they “get it right.” I’m sure you all read the headline about the 20-year old who committed suicide after thinking he had lost $730,000 trading options. (Forbes) It is possible that he hadn’t actually lost the money, but that his balance was in the red temporarily until all the options cleared his account.

 

Other investment items of interest

The SEC Regulation Best Interest (BI) rule went into effect June 30. At face value, it would seem that it would protect investors, ensuring that financial advisors, stock brokers, etc. put the clients’ interests first. While a step up from the “suitable investment” guideline of the past, it does not preclude a financial advisor from considering its own firms’ payment when making a suggestion to a client. It falls short of the “fiduciary rule,” which was vacated by a federal appeals court in 2018. This Regulation BI has not gotten a lot of press. Part of the reason may be that brokers and advisors are working from home, so it hasn’t gained traction, and part of the reason may be that commission structures have been evolving recently anyway (with the race to zero commissions on retail trades), and this new rule is more of an evolution than a revolution in terms of broker compensation and transparency. (NYT) (Investment News)

 

Finally, if you are a Warren Buffett fan, Validea Blog summarizes Buffett’s “eight timeless contributions” to the investing world.

  1. Educating/consistently conveying investment philosophy
  2. Controlling emotions and resisting biases
  3. Maintaining a positive long-term outlook
  4. Buying stocks when they “go on sale” (when stock prices drop, take advantage and buy!!!)
  5. Evolving investment focus when necessary
  6. Focus on paying the lowest (no) fees on investment products
  7. Respecting simplicity (understand what you are investing in)
  8. Giving back: Buffett contributes 99% of his wealth to philanthropic endeavors.

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