Dale: Hi, my name is Dale Yahnke. I’m the co-founder and CEO of Dowling & Yahnke. I’m joined today by Will Beamer, our President and Chief Investment Officer. We wanted to give you an update about what’s going on both in the market and at our firm. These are clearly scary and historic times. We wanted to give you an update on what’s going on in the market and what we’re doing at Dowling & Yahnke behind the scenes to help.
The world has changed in many ways. April will be a very difficult month. It’s when the expectation of deaths will peak and hit an apex. The demands on our medical system will peak as well. There will clearly be hot spots worldwide. When you look at what’s been going on with social distancing, our hope is that by the end of this month we will see the other side of this crisis.
I think that the virus just increases the stress level that investors are feeling. Therefore, we wanted to give you an update of what’s been going on at Dowling & Yahnke with regards to our ability to service our clients and stay in business. We have an exceptional IT Department and a Business Continuity Committee that has been working on setting up our team to work from home in case of an emergency well before the crisis happened. This action has helped us to continue to provide seamless service. Our demands on trading and planning have gone up significantly, and we’ve been able to meet those demands. We can happily say that the systems and communication within our company and clients have worked extremely well while working remote.
We are also extremely pleased to report, from a health perspective, we have no cases of COVID-19 amongst any of our employees or their families. Safety comes first, and it’s the reason why we’ve been out of the office the last several weeks. It would appear we may return back to the office at the earliest on May 1st. However, we think that return date is probably unlikely and will continue to monitor the CDC’s and health officials’ recommendations.
The one thing that we have missed tremendously, at least I can speak for myself, is the social side of the interaction that we have with our employees. We very much miss the interaction we’ve had with our clients as well. We have been able to connect through video conferencing, phone calls, and emails. However, that doesn’t replace the social interaction that we love to have and that makes us love the business we’re in. To recap, safety comes first. The volume of work that we’re putting out has been extremely smooth and the volume has been greater than what we normally experience, and we are proud we have been able to implement that volume of work remotely. Now, I’m going to pass the baton over to our President, Mr. Beamer.
Will: Thanks, Dale. I echo what Dale said about the fact this has been an incredibly difficult period, both emotionally as well as financially. To have people sort through financial stress, compounded by medical worries for themselves, friends, and family, has made this all that more emotional.
The markets are experiencing an incredibly turbulent ride. If you take a look at the left-hand side of this chart on slide five, you can see the Volatility Index for the S&P 500. It was very tranquil up until about February 20th. As the enormity and significance of the COVID-19 pandemic became apparent, the Volatility Index went from the mid-teens, which is a pretty normal, to over eighty, which is about where it was during the worst days of the global financial crisis back in ’08 and ’09.
Another pretty incredible statistic is since February 24th, the S&P Index has closed more than two percent higher or lower than the previous day on 21 out of 24 trading days. On eight of those days, the S&P actually had a 5% up or down move. That’s highly unusual. The black bars on the graph represent 5% moves. We haven’t had a 5% move in the market since 2011. I haven’t seen this level of volatility in my career since the global financial crisis in the ‘08 and ‘09 period. This volatility certainly generates a lot of stomach churning and anxiety on investors.
Not surprisingly, stocks had a dismal quarter. In fact, it was downright lousy. Large Cap stocks were down about 20%, Foreign stocks down about 23%, Small Cap stocks were down over 30%, and Real Estate stocks were down at 29%. These percentages represent a pretty brutal period for stock investors who were riding high, as recently as February 19th, when the market was at all-time highs.
The one bright spot was seen in diversified portfolios. When I say diversification here, I’m talking primarily about having a significant part of one’s portfolio in high quality bonds. Diversification worked this quarter. On slide seven, we’ve created a number of illustrative portfolios using market indices ranging from all stocks, which is the light brown portfolio, which was down about 22% for the quarter. The purple line, which is an all bond portfolio, represents high quality, government bonds (Treasuries) which was up about 3% for the quarter. Our typical or average portfolio is a balanced portfolio with about 40% of its money allocated to bonds. Bonds are represented by the light green line on the chart.
A 60/40 portfolio, using market indices, was down about 12% for the quarter. I certainly would not characterize this as a fun experience for anyone. But, for a long-term investor with a long-time horizon in the emotional discipline and wherewithal to stick with the plan, it’s probably not catastrophic either. When you have a big, sudden drop in a market like this – and this has been the fastest bear market in US stock market history – you have to resist the temptation to bail out and give up on stocks at what might prove to be the exact wrong time.
I think it’s helpful to take a look and see what history tells us about how the market responds to crisis. When we look back, we see seven different financial big hits such as 9/11, the 1998 Asian currency crisis, and the collapse of Long-Term Capital. Those events came out of the blue. Some people might refer to these events as “black swans.”
Over the next one-year period, there were variable returns. After the stock market crash of 1987, the market was up 19% a year later. After 9/11, the market was down 1%. The only point I would make from the one-year returns, at least in none of these seven crises, was the market down significantly more a year later. In the performance of a 60/40 portfolio (60% stocks and 40% bonds), what’s instructive to me is if you look out three or five years (the yellow and green bars on the graph on slide eight) you see some attractive returns. A 60/40 portfolio is up 76% in the five years after the stock market crash of 1987. It was up 81% five years after 9/11. The US debt downgrade happened in August of 2011 and five years later, a 60/40 portfolio was up 42%.
So, as dark as the news is right now and as worried as all of us are about financial matters, this may be a really bad time to take any severe action on your portfolio. Historically, returns out three to five years are likely to be reasonably good from here.
Another piece of market history I think is helpful to look at is the trends of bull and bear markets. The blue section on the graph (slide nine) shows periods of an upward trends in the market. The red section shows when the market has hit a 20% bear market. It then shows how long it lasted. The first thing that jumps out is the upward trends (blue) in the market tend to be of much longer duration and much higher magnitude than the periods of red. We are currently in a period of red, and the information it’s so fresh that it doesn’t even show up on this slide because this slide only goes through December of last year. How long that will last is anybody’s guess. The market will continue to adjust to news about both the pandemic itself as well as its economic impacts. Our hope and suspicion are that it will probably start a new upward trend, but exactly when that happens is anybody’s guess.
The government really has responded aggressively to the coronavirus pandemic. A lot of people ask, “Well, is this going to be a depression or is this going to be another ’08 or’09 all over again?” The core cause of this crisis is related to public health. The government is trying to effectively suspend the economy during this period of social distancing so that we can flatten the curve and not overwhelm our health care system. The problem with suspending the economy is it creates a lot of dislocation for individuals, small businesses, and for the stock market. The Federal Reserve was the first to really act. They came in and moved very quickly and aggressively. They cut interest rates, they significantly expanded their balance sheet by buying assets and provided liquidity to markets. They implemented some new programs to really backstop what I would call the “plumbing” of the financial system, the repo market, the commercial paper market, money market funds, that allow people to trust other counterparties, get transactions done, and get short-term financing.
Congress stepped in an impressively bipartisan fashion. We seem to be able to get bipartisanship when there’s a true crisis, which I suppose is reassuring. They passed the CARES Act on March 27th, which was quickly signed into law by the President. This is a massive stimulus and relief package, about $2.3 trillion, which is about three times the relief package that was passed in 2009 in the wake of the great financial crisis. It provides relief for workers, taxpayers, and small business owners. It provides relief for affected industries like airlines, state, and local governments. There’s no way I could go into all the detail in this particular act right now, but a lot of money will be flowing into the economy to take care of people who have really been dislocated by what’s happened in the last couple months.
A couple of provisions that are of primary importance to many of our clients are distributions from IRA retirement plans. For those who are subject to required minimum distributions, those requirements are waived for 2020, so you don’t have to take distributions from IRAs. A lot of people will be getting checks from the government, both adults as well as children.
On the small business front, the Paycheck Protection Program will lend $350 billion dollars in forgivable loans to help small businesses stay afloat during this period of time until we have more relaxed social distancing policies and allow them to retain their workers. Those are a few of the highlights of the Paycheck Protection Program.
There’s already talk about whether Congress will pass an additional stimulus package. This is probably quite likely, but the timing magnitude will really depend on where we go with regards to social distancing and how long we have to have huge sectors of our economy effectively shut down. There’s some talk that the next package may have some emphasis on infrastructure like rebuilding bridges, expanding airports, and highways.
Dale, I’ll turn it back over to you. You can talk a little bit about some historical periods you’ve seen, as well as what Dowling & Yahnke is doing for our clients.
Dale: Thank you, Will. I appreciate the summary. We like this chart (slide eleven) which shows a fifty-year period. There are no shortages of crises over the last fifty years that have caused market correction. When you look at it in perspective of fifty years, you can see that the market always come back. If you think markets work, this is what you would expect to see.
The chart on the right (slide eleven) shows how people’s emotions sometimes causes them to do things that aren’t necessarily in their best interest. We have periods that go from optimism to elation. You can see six weeks ago we were hitting market all-time highs, back down to nervousness, to fear, and then back to optimism.
What’s unusual about this correction is that it has happened in such a compressed time period, which I think just further exacerbates people’s stress and fear levels. I’m old enough that I can remember all these things that have happened over the last fifty years, and I’ve always had confidence that the markets will come back. You’ll notice when you look at these is that they’re all different. I get the comment a lot from people when they talk about these things when they happen and when you’re in the middle of them as well it’s different this time. My response is, “It’s always something different, there are always things that are going to happen.” Sadly, if we look at the next fifty years, it’s likely we’re going to see a lot more of these things that have happened overtime. Assuming that markets work and the economy recovers like it has, then these will be short lived things and we will get over them.
I think the question then is, “Well, what can we [Dowling & Yahnke] do when times like this happen?” One thing we have done is reach out to our clients to have conversations about sticking with a long-term plan.. We can, and probably should, update those plans in the coming months.
Secondly, when things like this happen, it gives us a chance to rebalance portfolios. When the markets go up, we tend to trim stocks. When markets go down, we tend to add to stocks. I know when people get trade confirmations, either in paper or electronically, and they see us buying things in a period where the markets going down and it can make people nervous. To quote Warren Buffett, “Be greedy when others are fearful and be fearful when others are greedy.” So, when the markets are going down, generally we’re going to be adding the stock positions.
You may also see trades happen when we do tax lost harvesting. In taxable accounts where securities have gone down in value, below what we paid for them, we can sell those securities and take the loss for tax purposes. Those capital losses can be used against capital gains going forward with no limitations. It adds to trading. Trading costs are exceptionally low today. Effectively, what we’re trying to do is harvest losses for the future when we have to rebalance and when the market goes back up.
We don’t know when the market will go back up, but sticking with your long-term plan, rebalancing, and tax lost harvesting are some of the things we’re doing behind the scenes that we think in the long run will add value to your accounts.
Again, we don’t mean to minimize how traumatic and scary this has been. We’re living through it along with you. Our workflow is increased dramatically. I’m very happy to say that we’ve been able to handle that increase in the workload seamlessly. A lot of credit goes to teammates that have done a great job of making sure we could function in a period like this. We want to make sure that you understand, from a communication point of view, if you want to zoom, email, or call, we’re here for you. Again, it’s a scary time. We’re here for you, and we will get on the other side of this.
Will, do you have any comments you like to finish up with?
Will: I think the only thing I’d say regarding the last chart (slide eleven) is that despite all of the bad stuff on this chart, the stock market worldwide has turned one dollar into fifty-four dollars over that period time. As a country, we’ve been through difficult times before. The attractive long-term returns of equities, that are often quoted in the press, include those tough periods and include those corrections in bear markets like we’re going through right now. We will get through this together. Dale said. “We’re here for you.” Please don’t hesitate to reach out anytime. If we miss anything, we miss that in-person interaction. We will do the best we can with technology to replicate it as best we can. Most importantly, I hope everybody stays safe and healthy.
Dale: Thank you, Will. Stay safe and healthy everybody. We’re here for you. Thank you.