The speed and turbulence of the stock market’s downturn in February and March was off the charts. Literally- March was the most volatile month since the Great Depression. The speed and move down made sense in many ways though, because of the closures and uncertainty caused by the pandemic.
The explosiveness of the market’s rally since late-March is more of a head scratcher to me. Much of the recovery can be attributed to the Federal Reserve and Treasury’s flood of cash that came in as quick as the bear market itself. The Federal Reserve and Treasury learned from the crisis of 2008 and provided help for small business owners through SBA and PPP loans. They aided individuals through checks and increased unemployment benefits and gave relief to big business through bond buying and market stabilization. Even with all of these monetary and fiscal actions, I am not sure many people would have assumed this level of comeback at current levels when they bottomed on March 23rd.
The SP500 was down close to 34% that day and remains in a 9.7% drawdown following a 36% rally ever since.
It is nearly impossible to imagine the crash we saw in February and March is now showing just single-digit losses on the year.
Tech stocks make up a majority of the Nasdaq 100, which remains one of the best performing indexes this year. Many of those tech stocks actually benefited form the “stay at home” culture.
Small Cap stocks were hit much harder as many of those small businesses were forced to close their doors for 8 weeks and it will take time for them to recover. The Russell 2000 can be considered a proxy for small business equities
Putting all of this together, you can see stock markets around the world have been more volatile than Tom Brady’s golf game. (I have no room to talk but I did find “the Match” amusing.)
We have not even made it to the halfway point of 2020 and it feels like I need a nap. Plenty of questions remain in the next few months. The answers to those questions are likely to provide continued volatility in 2020. I don’t have any answers to many of the questions, but some folks are asking me, “Where is the opportunity in this market?” This has led to even more research than normal as I make portfolio adjustments and look for opportunity. I wanted to walk you through my process I take for clients and for those who are just reading my blog on a regular basis but prefer to manage their own investment portfolios.
There was a chart released by KPMG showing the “Financial Factors impacting industry vulnerability”.
This shows the impact of Covid-19 on various industries. They can be divided into 4 quadrants: those that surge vs those seeing a hard reset of their business model. (Many industries will need to transform to re-emerge in a nimbler state, some can get by with modifications as a bridge to the future.)
People often ask what to do in a very uncertain economic situation. While it wouldn’t be prudent for me to give someone I don’t know specific advice, I can document what I am looking at for my clients. I am looking for opportunity in the top right and bottom right quadrant, specifically those industries that have the lowest “net debt” to EBITDA and the lowest current enterprise value to EBITDA. This is where I believe you can find bargains moving forward in a Covid-19 world. I believe the bottom right quartile provides opportunity for those individual businesses looking to make a minor adaptation to excel earnings. It is important to find companies that are not waiting for things to “go back to normal” but are constantly looking to adapt to bring value to its shareholders for years to come.
- Find a few different industries you are interested in investing in
- Look at each of those industries and find the “best of breed” company in each area
- Solid Balance sheet
- Good debt to equity ratio when compared to industry peers
- Consistent management team with a track record of growth or a sustainable dividend
- Competitive forward Price to Earnings ratio when compared to peers
- Once that analysis is completed you have a few different companies you would consider adding to your portfolio
- Perform a risk analysis on each company as it pertains to your overall portfolio
- Riskalyze- a 3rd party risk assessment company
- Morningstar report – specifically looking at your portfolio’s beta, standard deviation, r-squard, etc.
- Two independent 3rd party analysis reports per equity holding
For those of you “do-it-yourselfers”, you have likely done enough research to feel comfortable with adding that company to your portfolio in a fashion that fits your risk tolerance. For those that don’t want to do it yourself, or are unsure if you want to do it yourself and invest in the 3rd party software, I would be happy to run a few different scenarios through Riskalzye, Morningstar and gather some 3rd party analysis for you. At that point, after those things have been completed, you can decide if you would like to do it yourself or work with an advisor.