Making Your Portfolio Wish List in Preparation for the “All-Clear” Sign
By Michelle Connell, CFA | 3 min read
The last week has been a wild roller coaster ride and you’ve probably watched your IRA pull back to its value in January 2017 — and then some! As of March 20, the S&P 500 is negative 28.33% year-to-date. It’s understandable that — when it makes sense — you would want to try to repair the damage to your portfolio.
But, a word of caution before you jump back in the water and “load the boat” with new investments. Remember that we arrived at this point due to uncertainty, specifically the uncertain economic impact of the coronavirus (COVID-19). Investment markets hate uncertainty, and we are facing more uncertainty now than we ever have. This uncertainty resulted in two damaging side effects last week: volatility and lack of liquidity. Both of these need to subside if you want to reenter the “water” and minimize your downside.
Also, valuations need to also be considered. Theory tells us that stocks rise and fall on them — the most common being the price to earnings ratio. But right now, no one knows what the “E” or earnings part of the P/E ratio is! No doubt earnings expectations for companies will be taken down drastically when they report their March 31st quarterly earnings and provide guidance for future earnings. Thus, there may be a second shoe to drop and the market may go down even further when these announcements are made.
What can you do right now?
- While we wait, create a shopping list of possible investments that you have considered buying in the past, but were too expensive.
- As you are waiting and sitting on cash, let it make some money for you by investing it in a solid money market fund that has the lowest risk possible. Government money market mutual funds only invest in U.S. Treasury securities and repurchase agreements collateralized by U.S. Treasury securities. Currently, yields for these range from 1.2-1.45%
- One way to repair your portfolio and help it achieve long-term growth beyond this downdraft may be small cap stocks. The Russell 2000 index has dropped over 39.04% this year. The sharp decline has squeezed the Russell 2000’s forward price-to-earnings multiple to less than 10 times, the lowest it has been since the financial crisis and well below its long-term average of 14.
The reason these stocks have been penalized is that smaller businesses tend to have thinner profit margins and potentially less of an ability to manage their costs than larger companies. However, the drastic selloff of small cap stocks presents an opportunity to invest in higher-quality and more-resilient small businesses at a discount.
- If you are chomping at the bit to buy individual stocks, it’s important to not only review the company’s valuation, but do an assessment of its balance sheet. Determine if they have enough cash to weather this economic storm (i.e. pay their debts). Could they be looking at a loss of a line of credit or inability to access the bond market as their bonds mature? It is also important to note that the virus is NOT the only reason that the investment markets unraveled. Ten years of low interest rates resulted in debt-to-equity ratios ballooning. As of December 2019, corporate debt was a record 47% of the economy.
- Some investment areas restricted to wealthy individuals could also be opportunistic. Distressed debt investing is one such area. This entails buying the bonds of firms that have already filed for bankruptcy or are likely to do so. These are companies that have reached this point because they have taken on too much debt.
Over the last ten years since the financial crisis, companies have loaded up on debt. Now, corporations in several sectors including oil, travel, and restaurants, may not be able to repay it. The distressed companies may need to declare bankruptcy, or restructure their debt, or reorganize the company. The bonds of these firms will start selling at huge discounts and some will offer opportunities for large profits. After the mortgage crisis, it was not unusual for this popular asset class to return 15-20%. However, it’s important to note that this area of investing takes a very specialized investment skill set. If you are interested in this area, be sure and find a professional with vast and successful distressed debt experience and a large firm behind them. And understand that this asset class is typically illiquid for several years.
We are facing uncharted and uncertain times, to be sure. Despite this uncertainty, I implore you to remain of sound mind and avoid making any panic-driven moves in regards to your investments. I am committed to serving the best interests of each of my clients, by offering wise investment solutions to increase their odds for financial success. Contact Portia Capital Management today to learn more about our services and how we can help preserve your portfolio during these uncertain days.
About the Author
Michelle Connell, CFA is the President and Owner of Portia Capital Management, LLC, the only Registered Investment Advisory firm in DFW to be founded by a female CFA. Ms. Connell is one of the highest-rated finance professors in the United States, currently serving as an adjunct professor at The University of Texas in Dallas and teaching the CFA Review for the DFW CFA Society. Ms. Connell works with her students and private clients to understand the value of crafting a portfolio that includes conventional products as well as alternative assets, including private equity, private debt and real estate, and allows investment portfolio creation with greater downside protection and more consistent returns.