All 50 states have now moved to ease Covid-19 restrictions, and signs of revived activity are returning to the U.S. and global economy. Initial jobless claims peaked in March, truckloads are starting to fill back up, air travel and hotel bookings are inching higher, mortgage applications are rising, and people are applying to open new businesses again.1 Meanwhile, the stock market’s rally since late March has been powerful and sustained (so far).
In short, things are looking up.
Signs of an economic rebound may serve as a signal for some investors to take action. Whether that’s getting back into the market, taking some profits off the table, or reallocating a portfolio to fit the ‘new economic normal,’ the nascent recovery may motivate investors to make some changes. If that sounds like you, here are three mistakes to avoid making now.
- Selling into the Rally/Taking “Profits Off the Table”
As the stock market rallies off the March 23 lows,2 investors may be wondering whether this is just a “dead cat bounce” within a bear market. Investors who are convinced that there is more downside left to go might see now as a good time to take some profits off the table, wait until the next down leg of the bear market, then get back in.
This investment thesis may hold up, but it also could be dead wrong. The point is that no one can know for sure, and guessing means in engaging in market timing – which I do not advocate doing.
Historically, event-driven bear markets have been steeper on the downside and shorter in duration than structural or cyclical bear markets, and event-driven bears have taken less time to recover. We also know that bear markets bottom out, on average, four months before a recession ends.3 So, if the economy starts growing again by late summer, historical evidence says we could already be in a new bull market.
Selling into the rally now may mean missing out on some of the returns of an early stage bull market, which could adversely impact long-term returns. In my view, the opportunity cost of being on the sidelines during a bull market is greater than the cost of participating in some downside in the short term if you’re wrong.
- Making Company or Sector-Specific Bets
The race for a Covid-19 vaccine has spawned quite a bit of speculation over which pharmaceutical company will win. The guessing game has made a household name out of the company Moderna, for example, as they have seen some promising early results. But at the end of the day, we cannot know who will be the first to develop a vaccine, and it is even less certain whether the drug will ultimately be profitable for the company or the pharmaceutical sector. It’s all just speculation, in my view, and that is a mistake for investors.
Other examples may include betting on companies that have thrived during the crisis, like grocery delivery services, video conferencing companies, or the producers of household cleaning products. Demand for all of these products and services are no doubt rising, but the thesis to own a company should go much further than assessing whether they did well during the crisis. An investor should also look at cash flow, profitability, debt, management, market share, and more.
- Adjusting Your Asset Allocation Based on Your Idea of the “New Normal”
Finally, I think it would be a mistake to adjust a portfolio’s asset allocation based on a personal assessment of what the economy’s “new normal” looks like. In the current environment, that may mean removing an energy allocation altogether and replacing it with more technology exposure. Or perhaps adding a significant overweight to healthcare and removing exposure to retailers and consumer discretionary stocks.
These allocation decisions may make sense on paper, but the end result could be a portfolio that is less diversified – and therefore riskier.
Bottom Line for Investors
As the economy shows signs of rebounding and the stock market rallies, investors may feel more, or less, confident about what lies ahead. At the end of the day, we are not out of the woods on this crisis yet, and I expect market volatility to continue.
Making a few tweaks to a portfolio allocation to reflect a changing economic outlook is always a good exercise. What I want to caution investors against doing, however, is using the market rally, gut feelings, or ‘new normal’ predictions to dictate market timing decisions or wholesale changes to an otherwise diversified portfolio. In other words, now is a time to stay the course and be nimble – not a time to change your course altogether.