How Should Investors React To Virus?

February 28, 2020

The coronavirus (COVID-19) continued to take a toll on markets on Friday, pushing U.S. stocks further into correction territory and leaving investors in shock. Friday's 3.5% decline followed a 4.4% drubbing on Thursday (the worst single-session decline for the S&P 500 since 2011), a 3% loss on Tuesday and a 3.4% loss on Monday.

In the just five trading session through Friday, the S&P 500 had shed 14%, putting it on track for its worst weekly performance since the financial crisis.

To put things in perspective, the S&P 500 had notched a record-high close as recently as last Wednesday, Feb. 19. A week later, the index is down 10.5% on a year-to-date basis and 15% from that high.

Talk about whiplash. Amid such extreme volatility and a constant stream of negative coronavirus-related news flow, many investors are understandably panicked and anxiously trying to make sense of what is going on. Should they do something or not? What should they buy or sell, if anything?

These are questions that come up time after time in any market sell-off, but they are important. How an investor responds to these types of situations plays a large part in determining how well their portfolio performs over the long term.

To Sell Or Not To Sell?

In the mainstream financial media, commentators frequently advise investors to “take a little bit off the table” when things get rough in the markets. But this vague, generic advice is difficult to follow through on.

What does “taking a little bit off the table” even mean? In a way, it’s a form of market timing. By selling now, an investor will at some point have to get back in, and how will they know when to do so?

No one knows how the coronavirus situation will play out, including its economic impact. Perhaps the virus will prove to be less damaging than feared, or perhaps it leads to a recession and a bear market.

But at this point, any forecast of what the impact could be is just speculation, and not the type of speculation a long-term investor should necessarily partake in. 

Just missing a handful of days in the market could have a drastic impact on an investor’s returns. According to J.P. Morgan, missing the 10 best days in the market from 1999 through 2018, cut annual returns in the S&P 500 from 5.6% to 2%. Missing the 20 best days in the market pushed annual returns all the way down to -0.33%.

Is that a risk you want to take, especially with the market already down 15% from its highs? Probably not. Not to mention, selling can have significant tax implications, which is something that commentators rarely discuss. Short-term capital gains taxes and even long-term capital gains taxes can completely negate any advantage from successful market timing.

Is Hedging Worth It?

Another piece of advice handed out during times of uncertainty is to hedge. Hedging can take many forms. Everything from put options to volatility ETFs to Treasuries to gold can be considered hedges.

Hedging, like any form of insurance, has a cost. Some hedges, like put options and volatility ETFs, can be extremely costly, especially now, with investors paying a premium for protection.

The Cboe Volatility Index, which plays a big role in the pricing of options and volatility ETFs, was last hovering above 49—its steepest level in two years.

Sure, if you bought the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX) last week at its lows, you are up 80% through Friday. But buying today might not give you those type of results. Most of the time, VXX trends lower due to roll costs from contango.

Case in point, even with the latest run-up, the product is down 21% from a year ago. You’d have to time your purchase perfectly to make it an effective hedge for a typical portfolio. 

VXX Still Down Year-Over-Year…

Treasuries & Gold

On the other hand, there is much more merit to the idea of Treasuries as a hedge. They are a tried and true part of any multi-asset portfolio and they often help smooth out returns.

When stocks go down, Treasuries often go up. In fact, U.S. government bonds have been performing so well, they’ve been going up whether stocks go up or down. The only problem with that is Treasuries are now trading at all-time high levels and with all-time low yields.

On Friday, the 10-year and the 30-year Treasury yields dipped to 1.15% and 1.66%, respectively—both record lows.

That means that investors buying something like the iShares 20+ Year Treasury Bond ETF (TLT) here aren’t getting much in the way of yield and are more susceptible to principle losses if interest rates rebound (bond prices and rates move inversely). 

Record Low For The 10-Year Treasury Yield…

Most analysts aren’t expecting rates to spike significantly, and they could fall further still (maybe even into negative territory like in Europe and Japan), but it’s obviously riskier to buy bonds now than it was only a few months ago.

The same goes for gold. The yellow metal is much pricier today than it was last year. 

Like Treasuries, gold can be an effective hedge for a portfolio, smoothing out returns to some extent. But it hasn’t been as consistent in that role as Treasuries, at least recently. For instance, on Friday, gold was down as much as 4.5%, even as Treasuries rallied to record highs. 

Moreover, gold prices are still well off their all-time high of more than $1,900. Prices also fell nearly 30% peak-to-trough during the financial crisis, weakening the argument that the metal is a robust hedge for any downturn.

Buying Opportunities?

For most investors, sitting tight and not reacting to the day-to-day developments of the coronavirus is probably the right thing to do.

There’s another option also—taking advantage of the cheaper prices in stocks to buy. As Warren Buffett said, “be fearful when others are greedy and greedy when others are fearful.”

U.S. stocks are substantially cheaper today than they were only a week ago. They could get cheaper still, but a strategy of dollar-cost-averaging new money into the market is an option for investors wanting to take advantage of the sell-off.

For unfussy investors, they could simply buy a broad market fund like the SPDR S&P 500 ETF Trust (SPY), the iShares Core S&P 500 ETF (IVV) or the Vanguard Total Stock Market ETF (VTI).

Others could take a swing at beaten-down areas that may be ripe for a bigger rebound should the coronavirus fears fade.

Stocks of travel-related stocks like airliners have been particularly hard hit by the virus, so the US Global JETS ETF (JETS) could be an interesting target for bargain hunters. At the same time, oil has fallen precipitously, bringing the Energy Select Sector SPDR Fund (XLE) to an 11-year low and a juicy 5% yield. That could be attractive for value and income-seeking investors.

JETS Hits Some Turbulence…

XLE is a value play, but another place investors can look to for bargains is a growth area—software. Video conferencing companies like Zoom Video Communications have been mentioned as beneficiaries of the current situation, but a lot of software companies could benefit from more people working from home and collaborating over the internet.

Software in general is an area that is likely to continue seeing growth, even if the economy sputters. ETFs like Invesco Dynamic Software ETF (PSJ) and Global X Cloud Computing ETF (CLOU) hold a lot of software stocks that have been extremely hot and haven't seen a lot of pullbacks. Well, now investors finally have that pullback.

  

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2

 

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