Why stay invested despite COVID-19
Legendary value investor Warren Buffett said, “Be fearful when others are greedy and greedy when others are fearful.”
However, that is easier said than done. Take the COVID-19 crisis for example. How can you not be afraid when infections continue to climb exponentially around the world? And although stocks are cheap right now, they were already cheap last week and even last month. Unfortunately, being cheap doesn’t stop stock prices from falling further. Also, economic numbers out of China were much worse than expected, meaning, we should brace for the severity of COVID-19’s economic impact. Holding on to precious cash seems to be the best strategy since nobody knows for sure when COVID-19 crisis will come to an end.
But there are compelling reasons why we should remain hopeful and believe that “this, too, shall pass,” strengthening the argument to stay invested despite the difficult times.
Forced liquidation The steep selloff happening today is no longer solely attributable to the economic impact of COVID-19. Note that prices of all financial assets globally have been falling sharply since February this year. These include gold, which is supposed to be a safe haven.
The main reason why prices of financial assets are going down is forced liquidation. This happens for many reasons. It can happen if a trader borrows money from his broker to buy stocks. If all the stocks in a trader’s portfolio go down sharply, his losses will balloon, and his broker will be forced to sell his shares so he can pay his margin loan.
Forced liquidation also happens when there’s massive mutual fund redemption. Mutual fund managers may not want to sell the stocks in their portfolios, but because the amount of redemption spike up when there’s panic, they have no choice but to sell stocks to fund these redemptions.
Algorithmic trading that is largely driven by computers has grown in popularity. When certain parameters are hit, selling is triggered regardless of price, fundamentals or liquidity.
The good news is central banks are aware of liquidity problems caused by current market conditions, including forced liquidations, which may have serious consequences for financial institutions and even companies with short term liquidity needs. As such, central banks are cutting interest rates, buying back bonds and providing liquidity to help stabilize financial markets. For example, the US Fed this month cut interest rates by a total of 150 basis points to zero. It will also buy back some $700 billion in government and mortgage related bonds and will offer $1.5 trillion in short-term loans to banks. Just last week, the European Central Bank launched a 750-billion euro debt buyback program called Pandemic Emergency Purchase Programme. During the same time, our very own Bangko Sentral ng Pilipinas cut interest rates by 50 basis points.
COVID-19 is temporary
Although the ongoing COVID-19 pandemic is scary and may be far from peaking, the good news is, given all the precautionary measures taken by governments around the world, there is a likelihood that it can be resolved by the second half of the year.
Note that after imposing a lockdown of Wuhan and other cities in Hubei last Jan. 23, China saw the number of new cases peak 21 days later. Soon after, the number of recoveries exceeded the number of new cases. On March 13, there were some signs of life returning to normal as Apple finally opened all 42 stores in China.
Meanwhile, after its citizen practiced self-quarantine and the government began massive testing last Feb. 20, South Korea saw the number of new cases peak two weeks later. On March 13, the number of recoveries exceeded the number of new cases.
Despite initial resistance, countries around the world are increasingly accepting that they need to impose measures to control the spread of the virus.
Governments have also allowed the private sector to develop testing kits to make them readily available and more affordable.
These measures should hopefully allow the number of infections to peak faster, allowing life and business activities to return to normal by the second half of this year.
Valuations
Last Thursday, the Philippine Stock Exchange index (PSEi) closed at 4,623.42 before recovering some losses on Friday. This is the lowest close for the index since Jan. 26, 2012.
Because of the recent steep decline, indicators show the valuations of Philippine stocks are close to or already at 2008 global financial crisis levels. At 4,623.42, the PSEi is down by 49 percent from its peak of about 9,100. During the global financial crisis, the PSEi bottomed after falling 56 percent from the peak.
Moreover, at 4,623.42, the PSEi is trading at only 9.2X projected 2020 earnings, or below the level where the market bottomed during the global financial crisis (11x).
At 4,623.42, the market is pricing in at least a 35-percent drop in 2020 profits. This is much steeper than the 27 percent earnings drop during the global financial crisis. In fact, the last time earnings fell to the said level was in 2010 to 2011.
While the economic impact of COVID-19 is seen to be severe, I don’t think it is going to be worse than the global financial crisis. This is because there is no systemic risk. In 2008, numerous countries and individuals were over-leveraged and there was a housing bubble. Moreover, central banks are now aggressively cutting rates and boosting liquidity, which should be good for economies once the pandemic is resolved. Finally, governments globally recognize the severity of the COVID-19 problem and are already rolling out fiscal stimulus programs to counter the effect of COVID-19. Manage risks, but stay investedThe next few weeks and months may still be scary, but that doesn’t mean we should stay away from investing. After all, there are already signs that the COVID-19 crisis will be eventually resolved . With stocks valuations now much cheaper, it can be a good time to be greedy. Just make sure to manage your risk by limiting the size of your investment to an amount that you can afford to keep for a long period of time and buy slowly. Prices can still go down before they go up and nobody knows when we will hit the bottom. INQ
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