The Wall Street Journal - 28.03.2020 - 29.03.2020

B4| Saturday/Sunday, March 28 - 29, 2020 THE WALL STREET JOURNAL. THE WALL STREET JOURNAL. Saturday/Sunday, March 28 - 29, 2020 |B5

2008-09 by making bankers and investors so complacent that they never sufficiently tested whether their assumptions might be wrong. Finally, in the run-up to the lat- est panic, many investors seemed to believe index funds and exchange- traded funds, which can offer broad diversification at extremely low cost, had somehow eliminated the risk of owning stocks. Our forebears, on the other hand, believed panics are the indis- pensable hygiene of markets, sweeping the investing landscape clean after every orgy of prosperity. That notion was captured bril- liantly by the illustrator Frank Bellew in a cartoon for New York’s “The Daily Graphic,” days after the onset of a market panic in 1873. An ugly giant straddles the street, sweeping up clouds of dirt and shreds of ticker tape labeled “BO- GUS BROKERS,” “SHAKY BANKS” and “ROTTEN RAILWAYS.” He wears tattered goatskins, his hair tangling into horns as it rises from his scalp. The caption reads: “Panic, as a Health Officer, Sweeping the Gar- bage out of Wall Street.” Bellew personifies Panic as the god Pan, who haunted the country- side of ancient Greece. Half-goat, moody and mischievous, Pan was the god of herds, manipulating them with the music from his pipes. He lurked in mountain caves, arising at midday to burst out of nowhere at startled travelers. No wonder the ancient Greeks called a sudden fear “panikos.” It came from Pan. He was also the god of fertility. And financial panics, through the ensuing upheaval, fertilize old ground for new competitors and transfer assets to those who can put them to their best use. Out of the boom and bust in wooden turnpikes in early 19th- century New England came the rights of way that railroads later followed with ease through the forests and fields. Out of the ma- nia for technology stocks that col- lapsed in 2000-02 came the glut of fiber-optic networks that make in- stant communication universal and cheap as dirt today. The U.S. and British economies “cannot subsist without sowing the wind and reaping the whirlwind of a

financial crisis two or three times in each generation,” wrote the financial journalist Horace White in 1876. Financial crises, said White, re- curred with “the regularity of clock- work, so that people pretend to know when to expect one by looking in the almanac.” The early U.S. suffered severe financial panics roughly once ev- ery13yearsonaverage,in1792, 1819, 1826, 1837, 1857, 1873, 1884, 1893 and 1907. People used to regard booms and busts as part of “an organic cycle of life,” not as outcomes that can be prevented or controlled, says Mr. Goetzmann of Yale. In that organic cycle, entrepre- neurs who think business condi- tions will improve “become cen- ters of infection, and start an epidemic of optimism,” the economist Wesley Clair Mitchell wrote in his 1913 book, “Business Cycles.” That optimism leads to a “flood tide of prosperity,” which washes away caution, creating euphoria that culminates in a crash—which, in turn, clears the way for recov- ery. Lather, rinse, repeat. In recent decades, psycholo- gists have shown that people tend to overweight recent experience in their predictions of the financial future. Because markets rise more often than they fall, the experience of most investors tends to be positive over time. The longer the good times roll, the more remote the chance of a decline will seem, the more overconfident

wind of emotion. “Wall Street is as much the natural field for panics as the prairie is for tornadoes,” said the finan- cier John Ferguson Hume in his 1888 book “The Art of Investing.” People then understood what we have forgotten: When you look into a bubble, what you should see in that mirrored surface is yourself. After all, it isn’t investments that make or lose money; it is investors, with our own excesses of greed and fear. And that means market panics aren’t a time for reaction; they are a time for introspection. So ask yourself: Have I been tak- ing more risk than I realize? Con- versely, how should I turn panic into opportunity? How can I improve my portfolio and restore a sense of control? Should I sell some stocks or funds to generate a tax loss I can use to offset gains or income? Do I have long-held mediocre or risky stock positions I’ve been reluctant to dump until now because that would have generated a taxable gain I’d no longer incur at today’s prices? Blind faith in tools for control- ling financial risk has never made sense. If risk could ever be eliminated, investors would immedi- ately turn so euphoric that they would drive the prices of financial assets sky-high—thereby creating an enormous new risk out of the absence of all the old ones. Investors should never stop trying to manage their risks. But they should never believe that they, or anyone else, can eliminate them.

net $233 billion flowed out from June 2008 through March 2009, the heart of the bear market when stocks became screaming bargains. Are they bargains now? Not really. One of the more reliable mea- sures of how expensive stocks are, the cyclically adjusted price to earnings ratio popularized by Yale University professor Robert Shiller, put the S&P 500 at 23.8 times earnings on Friday. That is more expensive than average and compares with 13.3 times when the last bull market began. If you believe that the damage the Covid-19 pandemic does to the global economy will be on par with the financial crisis and plan to wait until stock valuations reflect that view, you will have to wait. To fetch a similar valuation, stocks might have to drop another 40% or more from here, leaving the Dow Jones Industrial Average well below 15000. But every downturn is different. A valuation measure like the Shiller P/E makes for a lousy timing tool. If you were content hav- ing, say, 70% of your savings in stocks last month when the Dow industrials were on the cusp of 30000 and the Shiller P/E at 32 then you should be at least as comfortable at 20000. That means buying more stocks and selling bonds as markets fall and repeat- ing that all the way down. If the last month truly con- vinced you that you had too much money in stocks to sleep well at night then take your lumps and dial back your risk permanently. But if you’re merely waiting for a sign that it’s safe to buy again then just hold your nose, increase your allocation to equities, and learn to love bear markets.

Learning to

Love the

Bear Market

hidden or delayed but never eliminated. And believing that panics have become obsolete is a precon- dition for their recurrence. The modern history of financial markets is a chronicle of attempts to control risk—if not eliminate it. One after another, they have all failed. “We trust these brilliant innova- tors in finance who seem to know what they’re doing when they try to control risk,” says Yale Univer- sity economist and financial histo- rian William Goetzmann. “And then, lo and behold, the risk miti- gation doesn’t happen.” The Federal Reserve was created in the wake of the Panic of 1907 to mitigate the risk of financial meltdowns. Some thought the problem could be solved. As the stockbro- ker DeCourcy W. Thom proclaimed in his postscript to economist Clement Juglar’s “A Brief History of Panics” in 1916: “Just as modern medicine is overcoming the dangers threatening the physical man, so is modern finance overcoming panic and the other dangers which threaten financial stability.” He was wrong—as similar fore- casts have been ever since. The Fed failed to stave off the crash of 1929 and, by not expand- ing the money supply in the early 1930s, probably worsened the Great Depression. In the mid-1980s, a computer- ized hedging technique called “portfolio insurance” purported to limit losses for big institutional investors; it ended up being partially blamed for the crash of 1987. In the mid-2000s, financial en- gineers created ever-more-com- plex derivatives as a way of carv- ing up and spreading risk. That, Federal Reserve Chairman Alan Greenspan said in 2005, “contrib- uted to the stability of the banking system” by allowing participants “to measure and manage their credit risks more effectively.” But risk can’t be removed; it can only be moved. The techniques hailed by Mr. Greenspan may have caused the financial crisis of

Continued from page B1

Why Market

Panics Can’t

Be Prevented 30

0

10

15

5

20

25

%

TIME SINCE START OF RECESSION

0 months 12 24 36 0 months 12 0 months 12 0 months 12 0 months 12

February 2020

Key: Rate during recession

Note: Seasonally adjusted annual rate Sources: National Bureau of Economic Research (recessions ended 1933 and 1938, recession durations); Labor Department (recessions ended 1975, 1982, 2009); Wall Street Journal survey of 34 economists March 18-19 (projections)

Looking for Work It's not yet clear if unemployment will surpass the jobless rates reached during the longest recessions since the Great Depression.

U.S. unemployment rate during longest recessions since 1929

Great Depression ended March 1933 43 months

2020

March 1975 16 months

November 1982 16 months

June 2009 18 months

June 1938 13 months

Projections through 4Q (from pessimistic to optimistic)

Baseline projection

Kara Dapena/THE WALL STREET JOURNAL

EXCHANGE EXCHANGE

Real gross domestic product, change from previous period

Contraction Calculation Some economists are now predicting a pullback in gross domestic product that would rival the severity of the 2008-2009 slump.

Projections Pessimistic Baseline Optimistic

Note: Quarterly figures are seasonally adjusted annual rates Sources: Bureau of Economic Analysis (past recessions); Wall Street Journal survey of 34 economists March 18-19 (projections); National Bureau of Economic Research (recession durations)

–15

–10

–5

0

5

10%

1930 ’31 ’32 ’33 ’34 1937 ’38 ’39 1973 ’74 ’75 1981 ’82 ’83 2007 ’08 ’09 ’10 2020 2020 2020

During longest recessions since 1929 and projections for this year

RECESSION

Great Depression ended March 1933

March 1975

November 1982

June 2009

June 1938

2Q

3Q

4Q

Kara Dapena/THE WALL STREET JOURNAL

Annual Quarterly

investors will feel and the more risk they will take. Only lately has that euphoria not seemed sinful. An early panic on the Amster- dam stock exchange was a natural consequence of the preceding bull market, when caution was “called foolishness, madness and crime,” wrote the pamphleteer Joseph Penso de la Vega in 1688. “The spirit of Ahab and Satan” had en- ticed speculators to join in the “ju- bilation” of soaring prices. Investors were frantic in 1720 as shares in the South Sea Co. soared

and then crashed in London. Only God could restore them to sanity, Jonathan Swift wrote the next year in his poem “Upon the South- Sea Project”: “May he, whom Nature’s Laws obey, Who lifts the Poor, and sinks the Proud, Quiet the raging of the Sea, And still the Madness of the Crowd.” Investors in ages past didn’t believe that the stock market was efficient. They thought it was— and always would be—a whirl-

When you look into a bubble, what you should see in the mirrored surface is yourself.

A Frank Bellew illustration, right, depicting the market panic of 1873 in New York’s ‘The Daily Graphic.’

The Wall Street Journal asked some of the financial world’s most influential voices to predict how markets and the economy will respond to government poli- cies designed to contain the im- pact of the coronavirus pandemic. They called upon their extensive experiences navigating selloffs and downturns, disrup- tive hurricanes and even terrorist attacks to advise investors on what’s coming next—and what they can do about it.

Scott Minerd Global chief investment officer, Guggenheim Partners

“We are running the risk that this will be another Great De- pression. Despite the good in- tentions of the Fed and policy makers in Washington, the pro- grams put in place won’t offset a severe contraction in economic activity. I expect another 10-20% downside in equities, and double-digit high-yield de- fault rates within 12 months. “My experience in all kinds of markets, including the financial crisis, is that bottom fish- ing is the most expensive sport in the world....Things that are cheap can still get cheaper.” —Justin Baer

Abigail Johnson Chairman and chief executive, Fidelity Investments

“It’s impossible to predict the direction of the markets. Investors face long odds in trying to time the ups and downs of the markets. Staying fully invested according to your asset-allocation plan can give investors an opportunity to participate in the market’s long-term upward trend. In- vestors need to be patient and disciplined, and have a plan. “Your plan can help guide you through periods like this. It can help to use what we call the investor mindset, which means staying focused on the long term and using a decision process that is analytical, logical, and grounded in empirical data.” —Justin Baer

William Ackman Pershing Square Capital Management

“The news about the virus is going to get worse and worse in the next few weeks, but the good news is that people are responding,” William Ackman said in an interview. In February, Mr. Ackman watched the coronavirus spread in China and thought the only way to slow it was to shut down the economy. So he moved to protect his portfolio, spending $27 million on convertible de- fault swaps as a hedge. Mr. Ackman called for a 30- day shutdown of the U.S. and told CNBC on March 18 that “hell is coming” and the country wasn’t moving fast enough to stem the spread. Markets slid as he spoke. Though a full shutdown didn’t happen, Mr. Ackman locked in the gains from his hedge earlier this week by clos- ing it out for $2.6 billion, off- setting his stock losses. Mr. Ackman says he has grown more optimistic, and while his portfolio includes a relatively high level of cash, he has put more money into core holdings. “I think we’re heading in the right direction,” he said, though he added that it’s likely “not going to be straight-line up.” —Corrie Driebusch

What

Happens

Next? Nelson Peltz Trian Fund Management

Hedge-fund manager Nelson Peltz is doing his social dis- tancing in Florida. When he takes a ride once a day to get out of the house, he likes to drive past a Wendy’s—the res- taurant chain in which his fund, Trian Fund Management LP, is the largest shareholder. While not as many people are using the drive-through as a few weeks ago, Mr. Peltz said he’s still pleased to see people lined up to get their food. Mr. Peltz says the coronavirus pandemic, and the shortage of medical protective gear and other supplies, will fundamen- tally change supply chains, and that the U.S. will likely see more things being made in America. In the near term, Mr. Peltz is feeling more upbeat after see- ing the stimulus bill pass in the Senate, saying, “the bill as writ- ten will help both companies and workers.” —Corrie Driebusch

Walt Bettinger Chief executive, Charles Schwab Corp.

“We know from history, over time, our country perseveres and its markets rebound. The hopelessness of the financial crisis of 2008 was followed by a historic bull market, but the pivot went almost unnoticed by many investors until we were well into the turnaround. And so throughout this downturn, we are reminding our clients that panic is not an investment strat- egy and that trying to time the market is futile.” —Dawn Lim

value is one that lost a jarring 30% and then another 30% after that. Investor psychology in a major bear market is a mirror image of what it was the past few years: The more false alarms there were on the way up, the likelier investors were to embrace risk, viewing dips as buying opportunities. On the way down, so-called suckers’ rallies—and the technical bull market we reached on Thursday may well have been one—get our hopes up and then crush them. By the time a really prolonged bear market is about to end, investors who haven’t sold in disgust probably have a lower percentage of their net worth in stocks than at the outset. That is one of the costliest mistakes investors make. A surprising share of a new bull market’s returns pile up in its very early stages when people are most fearful. Take the one that ended last month. Putting $100,000 into an S&P 500 index fund on the day the bull began on March 9, 2009, and selling at last month’s peak would have seen that turn into $630,000 including dividends. Waiting just three months to make sure it wasn’t yet another head fake would have earned you only $450,000. If you wait for happy headlines or hopeful government statistics for a clue for when to pounce,

Continued from page B1

you’ll be too late. Stocks typically rally before a recession is over. For example, imagine an investor who went back over the last eight recessions, all the way back to the Great Depression, and bought the S&P 500 or its predecessor index at the bottom of the accompanying bear market, only to sell as soon as the recession officially ended. This market-timing genius would have made an annualized return of over 64%. That compares to a

long-run annualized return for U.S. stocks of about 9.7%. Making lemonade out of the market’s lemons sounds tempting, but it isn’t easy. The old saw goes that the stock market is the only one where people run away when there’s a sale. Beforehand they crowd in when the wares are most expensive because they see everyone else get- ting rich. For example, in the 10 months leading up to the last market peak in October 2007, a net $84 billion flowed into equity mutual funds according to the Investment Company Institute. By contrast, a

A surprising share of a new bull market’s returns pile up in its very early stages.

DAILY GRAPHIC: LIBRARY OF CONGRESS; MINERD, JOHNSON, PELTZ: REUTERS; ACKMAN: BLOOMBERG NEWS; BETTINGER: GETTY IMAGESALEX NABAUM

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The Wall Street Journal - 28.03.2020 - 29.03.2020

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