The term “going viral” has been extremely popular during the internet age. The Coronavirus is a stark reminder of this term’s roots. When something is highly contagious, it spreads quickly. The reason that internet videos, as well as actual viruses, spread so quickly is due to the mathematical impact of the multiplier effect. The amount of people exposed is not an additive equation, it’s an exponential equation. Each time a person contracts the virus, or watches a video, they tend to pass it along to multiple people. Suddenly large numbers of people are infected. When the multiplier effect is applied to the latest internet sensation it can be very profitable, when it’s applied to an actual virus, it’s extremely concerning. Understandably, we’ve received several emails from investors worried about the impact of the Coronavirus on their portfolios. Within each email are various iterations of the question, "is GreenPort planning on selling stocks or becoming more defensive"? The short answer is no. Earlier today we actually added to our overall portfolio risk by lowering duration (interest rate exposure). Duration is negatively correlated to stocks and protects the overall portfolio when stocks sell-off. We sold a portion of your longer-dated bonds which have more duration, and replaced them with shorter-dated bonds which have less duration. Reality is we don’t have a unique insight into the Coronavirus; therefore, we don’t have a competitive edge making trades based on what we think is going to ultimately happen. On the other hand, we do feel we have a competitive edge when it comes to portfolio construction. A main tenet of our portfolio construction methodology is that investors are unable to profitably predict and explain the majority of short-term market movements. Our acknowledgment of this inability is a competitive advantage for GreenPort. Most investors are overconfident in their ability to explain and profit from short-term market movements based on the news cycle. This leads to emotional decision making, as opposed to logical decision making. As hard as it is at times, we do our very best to base our decision making solely on observable economic data. Only about a quarter of the S&P 500 corporations have reported Q4 earnings so far. That said, the reported numbers are once again beating analyst expectations. 69% of companies have had a positive earnings surprise while only 23% have had a negative surprise.
Both revenues and earnings continue to make new record highs. If the Coronavirus becomes a pandemic, it will impact all earnings. So far, the earnings impact is mostly contained within the travel industry.
Our reasoning for lowering our duration exposure is somewhat straightforward. We keep duration in the portfolios to protect your assets from unexpected stock market self-offs, such as last week. Duration is negatively correlated to stocks. When stock markets lose value, bond investments with duration usually add value. Duration has once again proved valuable during this latest pullback in the stock market. The Core Portfolios have weathered this sell-off fairly well. However, as interest rates drop, not only do bonds become overvalued relative to inflation, they have less ability to protect your portfolio as interest rates approach zero. Our duration framework indicates that longer-dated bonds with higher duration have become overvalued. Specifically, 10 Year yields relative to inflation are at historic lows.
Although it is uncomfortable, our frameworks recommend lowering duration (interest-rate risk), which will increase the overall risk in the Core Portfolios. Our longer-term frameworks indicate interest rates have overshot to the downside. There will no doubt be more market volatility before we have a clearer picture of the Coronavirus. Admittedly, we don’t know how this ultimately plays out. Our guess, and it’s only that, is that people far smarter than us will figure out a way to contain this virus, in the same manner they figured out how to contain SARS, Ebola, and the Swine Flu. Until then, we will continue to monitor the markets and economic data, and position the Core Portfolios for success. Stay Healthy, The GreenPort Team