What Did You Expect?

By FirstWave Financial

Many states are attempting to re-open their economies at varying rates of speed. Individuals are participating (or not participating) in that re-opening depending on their interpretation of the status of the pandemic and their own personal health situations. Due to this, we are seeing large swings in stock prices day-to-day and sometimes even during a single day.  

Take Monday, June 15th as an example. The Dow closed on Friday, June 12th at 25,605. It opened the following Monday already down 335 points at 25,270, only to fall to 24,843 in morning trading. This 762 point drop from Friday’s close was partially contributed to the headlines of increased coronavirus cases being detected across the country. The Dow closed that day at 25,763, while only up 158 points from its close the Friday before, it was up 920 points from its low just hours before. Added together, the Dow traveled 1,682 points from its close on Friday, to its low Monday morning, to its close on Monday afternoon. 

What happened between 9:30am Monday morning and 4:00pm that afternoon? Was there a big decrease in the number of new COVID-19 cases? Of course not. Could it be that the actual number of new cases has little to do with the value of the stock market at any given time? Quite possibly. That’s because stock prices move up or down based not as much on the data being reported, but how that data compares to what was expected to be reported. Everyone expects there to be an increase in new COVID-19 cases now that more people are being tested and most of us are no longer under mandatory stay-at-home orders. The consensus opinion of this increase in new cases is already built into current stock prices. If actual cases increase, but not as much as expected, stock prices may rise. If actual cases increase more than expected, stock prices may fall. In both examples new cases increased, but with possibly opposite effects on stock prices. 

A similar scenario happens with company profits and stock prices. How can a company’s stock price fall when its profits are increasing? Because they are not increasing as fast as was expected before their actual profits were made known to the public in their financial statements filed with the SEC. This previously unknown information (actual profits) compared to what was expected is what made the stock price change. 

The point here is that the current value of widely-held publicly traded stocks (like those traded on the NYSE) reflects all currently available information at all times. That is because millions of buyers and sellers are digesting that information and forming expectations about its effect on future stock prices. The price at any given moment represents the agreement between sellers (who think the price is going to go down based on all that information) and buyers (who think the price is going to go up based on that same information). Stock prices change (up or down) when new information becomes available supporting or refuting those expectations.

A proven way to help protect the stock portion of your portfolio from the volatility caused by actual events occurring that are different than what was expected is to lengthen your time horizon. This can be accomplished by considering investing only that portion of your investment portfolio into the stock market that you can reasonably expect to keep invested there for at least five years; not necessarily in the same stocks, but in the broader equity market. 

Keeping the part of your portfolio that is sufficient to provide any cash flow that you may need over the next five years in short-term, high-quality bonds will help you avoid selling your stocks for cash needs when the market is down. When the stock market is up, your rebalancing trades can be used to provide cash. When the stock market is down, your cash flow can be provided by bond sales which fluctuate very little in value. We have seen stock prices fall as much as 50% in the short term and when applying the approach described here, day-to-day or intraday volatility is easier to withstand or even ignore since it has little to do with your long term investment goals. Having your cash flow protected provides the empirical and emotional support needed to weather this volatility and improve your WealthConfidence.

If having your wealth grow faster than the rate of inflation is important to you, then investing some of it into a globally diversified portfolio of stocks could help achieve this goal. Accepting the efficiency of the market that reflects all available information at any given time, lengthening your time horizon, and using bonds to backfill cash flow needs and dampen volatility could increase your likelihood of having a successful long-term investment experience.

We are grateful for the relationship we have with you and appreciate the trust and respect that we share. Please feel welcome to contact us for any and all reasons as we get through this time together.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product, or any non-investment related content, made reference to directly or indirectly in this publication will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this publication serves as the receipt of, or as a substitute for, personalized investment advice from FirstWave Financial. A copy of the FirstWave’s current written disclosure statement discussing our advisory services and fees is available upon request.