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The year 2020 shall be remembered in financial markets as one of the most turbulent, frustrating and utterly unpredictable years in recent history. From the precipitous fall in March to the breathtaking rally that followed, the year has served as a valuable reminder of some tried-and-true investing principles that have shaped the world of investment along the years. As we embark on a new year of investing opportunities and challenges, it is worthwhile revisiting some of these principles and committing them firmly to memory.
The first lesson is that crises come out of nowhere and as such, it is important that investors always invest in line with their investment objectives and risk tolerance. After a big recovery year in 2019, some might have been worried about high equity valuations, low bond yields and maybe the US election-related volatility. Nonetheless, no one had really pencilled in a once-in-a-century global pandemic that would shut down a good portion of the world economy and force us to live our lives virtually for months on end.
The crisis triggered a panic selloff of huge proportions, prompting many investors to call their financial advisors, asking them if they should move to cash, shift around their allocation or even get out of stocks altogether. Anyone who sold off stocks at that time would have dealt with massive losses, and while they waited for the right time to jump back in, stocks rebounded so quickly that these investors missed out in the gains. This brings us to the conclusion that investment decisions should be based purely on what we can control which means sticking to a pre-set asset allocation and choosing the right investments according to our risk profile.
This brings us to the second lesson which refers to the fact that the market looks ahead and is not driven by short terms events. Investment prices do not always move in the same direction as the overall economy. This might not have seemed apparent right after the pandemic struck in mid-February, as the overall economy and the stock market took big hits. However, just a couple of weeks later, the markets began a rally that lasted several months. During this time, the economy also recovered somewhat, but still remained on weak footing. This discrepancy can be explained essentially by the fact that, economic numbers, such as the unemployment rate and gross domestic product (GDP), reflect what’s happening today, but the markets are always looking months ahead, which means they are anticipating a stronger economic recovery and the results that come with it, such as greater corporate earnings in 2021.
The third lesson is that even in this ultra-low interest rate environment, high-quality bonds still have an important role to play in most investors’ portfolios. The lesson was reinforced after the market plummeted. Owning high-quality fixed income provided a psychological benefit by minimising volatility, which helped investors keep their emotions in check. It also gave investors a buffer from which to withdraw money if their income was reduced due to the state of the economy. Since bonds fluctuate much less than equities, they could sell a bond, instead of their stocks at steep losses, to help make ends meet. Moreover, bonds also provide attractive rebalancing opportunities that may improve one’s return over time. A rebalancing after the crash in March would have led to buying more stocks, leading to a favourable position to enjoy the gains of the rest of the year.
Another key element of achieving successful market returns is knowing when to buy. Warren Buffet put it best when he said, “be fearful when others are greedy, and greedy when others are fearful.” But as accurate as that mindset is, actually buying during a downturn is psychologically difficult. In a crisis, human instinct is to flee to safety. The idea of investing more money in a market that appears to be crashing can feel foolish. However, investors really need to focus on their long-term plan. Implementing strategies to manage emotions and the actions you take is imperative. A euro cost average plan can take a lot of the heartache out of making these decisions. Further, those who put new monies into the market – particularly near the bottom – have been rewarded for their courage. While these are short term returns, it’s evidence that investing when other are running scared can make a difference.
Another lesson we learnt from an insane 2020 is that opportunities will always exist for investors. Although the coronavirus seems unprecedented, the equity markets have rebounded from many crises before it. From war to global meltdowns, the market has seen it all. But even at the highest of these events, when the markets might be more affected, individual segments or industries can do well. For example, in the current environment, when many people have been forced to work and shop from home, and get their entertainment online, it’s probably not surprising that some parts of the technology sector have seen their economic activity grow, along with their stock prices. The point is that there are always investment opportunities around the corner, especially in times of market stress – and smart investors will find them and incorporate them into their portfolios in a way that’s appropriate for their goals and risk tolerance.
Finally, another big lesson we relearned last year is that shorting stocks is really hard and incredibly risky. If a stock you buy goes to zero, you can only lose 100%. However, if you short a stock, your losses are unlimited. If there was ever a time to be short stocks, it would have been in March last year. However, the time window in which you would have profited from such a strategy would have been pretty short. After the March crash, stocks went on to enjoy an unprecedented recovery - in fact, the fastest ever from a big market correction.
For many reasons, it’s unlikely that we will see anything exactly like 2020 again. But some of the investment lessons we learned last year are applicable in every year – so keep them in mind for 2021 and beyond.
Disclaimer:This article was issued by Stephen Borg, Head of Wealth & Fund Management at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.
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