Our client letter this past April was published just as the world was coming to grips with the stark realities of the Covid-19 pandemic. Shelter-in-place orders had just been issued for all of the world’s major population centers. Sports leagues suddenly cancelled their seasons. Schools shut down. And the economy was grinding to a halt. The stock market had already anticipated the impacts of these dramatic events, with the S&P 500 plunging 30% from mid-February to mid-March.
At that time, much was unknown about how the rest of the year would unfold. Indeed, much remains unknown today about how and when this pandemic will end. But in that April 2020 letter we did express some of our long-held convictions about why investors should not abandon all hope in stocks despite the unprecedented events of the prior six weeks:
- Investors in well-diversified portfolios can be confident in the overall stock market, even while the market sorts out the winners and losers from the pandemic’s economic impacts
- Stocks often turn around when we least expect it and make a rapid and dramatic recovery
- Human ingenuity is a tremendous resource and often underappreciated in times of crisis
In hindsight, it’s interesting to see how vividly these points were illustrated during the remaining nine months of 2020. We provide examples of each in the sections that follow, and please know we don’t present them to gloat, or to claim we had some divine insight as to how the rest of 2020 would play out. These are, in fact, the same convictions held by many investors, both professionals and individuals. But they are easy to forget in the fog of momentous events, and we feel it is worth re-examining them now because they proved to be solid principles once again in 2020.
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We have mentioned before that the risk of owning individual stocks (known as security risk) is significant. Investors with concentrated stock positions are vulnerable to unforeseen and unknowable events that can materially impact those companies. These events can be either internal or external, but the result is often devastating regardless of the root cause.
Security risk was on display in 2020 as never before. One of the most startling aspects of the pandemic’s economic impacts is how arbitrarily it determined the fates of companies both large and small. Unlike the systemic impacts of the 2008-09 financial crisis, the 2020 pandemic impact on stocks was more about sorting out winners and losers than about a financial system on the brink of collapse.
Just a few months prior to 2020, no one could have anticipated that the entire world would literally shut down for weeks the following spring. Amazon didn’t do anything in 2019 to be sure it was well positioned for the 2020 shutdown, nor could Delta Air Lines have taken any steps to anticipate that billions of people would stop flying. The shutdown was an unforeseen event that was as random as the spin of a roulette wheel.
The below graph shows just how random it was, highlighting the stock performance of some of the biggest winners and losers from the shutdown during the first nine months of 2020:
Some investors who were concentrated in the stocks of the “losers” in the pandemic fallout may never see their portfolios recover. Hertz, for example, filed for Chapter 11 bankruptcy protection last spring, rendering its stock almost worthless. Carnival Cruise Lines could possibly be headed that way as well.
To us, the most frustrating aspect of this is that security risk can be almost completely eliminated through diversification. There is simply no need to incur the risk of a concentrated stock position – and yet countless investors choose to bear that risk anyway.
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To be sure, investors in well-diversified stock portfolios aren’t immune to risk. It’s just that they are assuming market risk, which is the inherent risk associated with stock investing. We saw this on display in the spring downturn that impacted all stock asset classes and investment styles.
While market risk can’t be avoided, it can be managed. Besides having a well-constructed portfolio, the most effective way to manage market risk is by staying invested and resisting the urge to flee stocks when the market goes into a tailspin. We made the point in our April 2020 client letter that stocks often recover rapidly and unexpectedly from such downturns, well before the news cycle has turned positive.
We saw this yet again in 2020. Looking at the performance of the major market indices and asset classes from 3/31/20 to 12/31/20, stocks climbed at a pace last seen (not coincidentally) in 2009:
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Human ingenuity is a vastly underappreciated asset when it comes to solving problems. The bigger and more urgent the problem, the more human capital that is devoted to solving it. In the case of the Covid-19 pandemic, more human capital has been deployed to this very urgent problem than any other event in history.
The fruits of that effort are already evident. The previous record for developing a vaccine approved for widespread use in this country was four years (for the mumps). Yet, in less than a year, we have two vaccines for Covid-19 approved for use in the United States; others are in use in developed countries in Europe and Asia. There are also another 64 vaccines in clinical trials on humans that have not yet been approved. (Source: New York Times Covid-19 Vaccine Tracker, January 6, 2021).
The vaccine development is the most high-profile indicator of mankind’s ability to tackle the most challenging of problems, but it is hardly the only one. We all have seen countless examples of individuals, companies, civic and charitable organizations, etc., finding ways to adapt to the challenges of the pandemic.
In real time, maintaining faith in our ability to resolve complex problems can be difficult to muster. After all, the crisis is a known entity, while the future resolution is unknown. And yet we can see, throughout the course of history, that we always find a way. Even though we may not have found our way out of the Covid-19 pandemic yet, we have made tremendous progress. Those who keep their faith in human ingenuity will be rewarded for it.