A Call for Discipline in the Face of Adversity

If you're alive (and hopefully one or two of you still are), then you're most assuredly aware of the sharp stock sell-offs which have now "officially" pushed markets into Bear territory for the first time since 2009. Though puncturing and confidence-shaking, recent weeks' activity is not permanent—nor is it the norm. As I was reminded by a colleague in the industry via e-mail last Wednesday, "This too shall pass."

The obvious question is, therefore, two-fold:

1. When will this pass? And...
2. What will the damage be by then?

If you're looking for a concrete answer to those two concerns, you may leave this article a bit disappointed. That's not what we do. We do not have a single client relationship for which our foundational value-add is "market timing."

That being said, context is important. Consider the following as it relates to economic recessions in the U.S.:

• Of the 14 recessions since the year 1900, six coincided with stock market declines of less than what has already been experienced (as of noon on 3/12/2020).
• Two more saw losses that were less than 2 percentage points worse than the current decline's bottom reached last week.
• The remaining six recessions lasted for an average time period of 18 months sequentially with the shortest lasting 8 months.

Narwhal doesn't have a consensus on what the final economic toll of the virus and its accompanying panic may be, but we have some scenarios that we don't expect. We do not anticipate an 18.2% decline in GDP like we saw in the late 1930s. We do not expect this thing to drag on for years like the Great Depression. We do not think this is a replay of the Global Financial Crisis. At this point, this seems more in line with the forgotten recession of the late 1950s (August 1957 - May 1958). The leading causes of that recession: Slowing sales, slowing construction, and slowing business spending. Similar themes could be in play in the event of mass office and business closings. We offer all this not as a prediction but as much-needed context. Not every down market is 2008. Not every recession is a depression. Economies can slow without unemployment hitting 10%. Markets can be bear markets without getting cut in half.

So, if we're not here to make market calls, what are we here for? We're here to bring discipline on asset allocation and thoughtfulness on investment selection. That's not new, and that's not a cop-out to avoid difficult times (more on that in a moment). Case in point, elsewhere on our website, we offer the following regarding the importance of asset allocation:

We believe we add as much value to clients in our allocation analysis and implementation as we do with our individual stock or bond selection. Accordingly, we take great pride in this element of our stewardship.

We care about each client's asset allocation ranges and targets. We build customized Investment Policy Statements for each client for that very reason. This isn't lip-service or back-patting. It's just our process. As we often tell clients, Investment Policy Statements are our tour guides. They tell us where we're going, why we're going there and how we plan to get there. They're crafted alongside each individual client, and they do change over time. Yet, they exist for a reason, and these documents are more valuable in times of quick market moves than in periods of relative calm.

None of this is to imply that we are immunized to the brutal correction of the past few weeks. We firmly believe that losses are more mathematically damaging than gains are joyful, and we invest through that worldview. That doesn't mean we avoid all losses. It just means declining portfolio values are exceptionally excruciating (though no less unavoidable) as we serve as stewards of client capital.

Discipline is difficult. It requires delaying gratification just as much as it requires persevering through periods of doubt. In 2019, as the S&P 500 raced to a gain of more than 31%, it was hard to be a net seller of stocks, but for most accounts, we were. We trimmed equity all the way up to stay on target with equity allocations. Did we leave hypothetical "dollars on the table" by doing this? Certainly. But it was true to our process, and we believe appropriate to client needs.

Now, it's hard to buy. The temptation for some clients we've spoken with has been to get out of (or at least, heavily reduce exposure to) equities. We understand the rationale for such reactions, but just as we talked clients away from increasing stock exposure 6-9 months ago in the name of discipline, we're advocating for more measured approached once again. To be clear: we work for our clients, and sometimes that means making concessions on our disciplines and changing targets to provide peace of mind. For most clients, however, we're maintaining the established course.

The point is this: market dynamics change quickly. Though valuations seemed high at the end of 2019 (hence this economic outlook by Chief Investment Officer Ben Nye and the aforementioned trimming of positions throughout the prior year), we could not have expected this confluence of events. But we can—and are—prepared for them through a disciplined approach to allocations. No, that does not mean avoiding losses, but compared to the stock market as a whole and the panic-inducing headlines tied thereto, allocations have helped. We don't have many clients who, on a total portfolio, are "up" for the year, but more than half of our clients have participated in this decline at a rate of less than 60%. The discipline matters.

In light of that, clients should know that we're here (literally and figuratively...arguably more than ever), and we are working. We're cautiously picking up under-valued stocks and chasing down bond opportunities as outside investors dump assets. We're not buying stocks that are projected to "win" from Coronavirus, and we're not getting cute with hedging strategies. We're buying large, blue chip stocks that we always want to buy...but at more attractive valuations than a few weeks ago. A few examples of recent purchases:

• Adobe - a company we added to the portfolio last year that just posted record quarterly profits.
• Blackrock - a dominant asset manager that is down about 30% from recent highs.
• Microsoft - a long-term holding for the firm (historically speaking) that is in a "buy" range for the first time in a while.
• Apple - See the note on Microsoft.
• Kimberly-Clark - A consumer staples company that traded down from over $148 to $122 in less than two weeks.

Stay disciplined...even if that means staying patient.

Andrew Hall is a portfolio manager and the Vice President of Narwhal Capital Management. He does not have the Coronavirus, but he kind of wants to try it.