The Wealthy Owl's playbook for surviving (and thriving after) the COVID-19 bear market

As I write this post on March 18th the world has been put on pause as countries around the world take aggressive action to contain the spread of COVID-19. The one exception is the stock market, right now some of us may wish trading had been put on hold but with each new day and each new headline the market makes a major move. The focus needs to be on treating the ill, social distancing, cheering on the medical professional heroes around the world who are risking their lives to take care of us, and protecting our vulnerable.

However, the anxiety and poor decision making that market crashes like the COVID-19 bear market cause cannot be ignored. We also need to protect our financial health, after we have put the practices and care in place to protect ours and our family’s health.

Over the last month, as the S&P 500 index has dropped 29% since its Feb. 19, 2020 high (as of market close March 18th), people can be excused for checking their RRSP or 401(k) accounts regularly. This is when your investor nerves are tested and the decisions you make will have significant consequences on your financial future.

With all the doomsday headlines over the last month, both COVID-19 and financial market related, many of my friends and family are not sure what they should be doing with their investment accounts. I am getting asked what investing decisions I am making during these very volatile times and so I thought I’d share my playbook for coming out of the COVID-19 bear market in the best possible position.

1. Get into the right mindset. If you have lived through a couple market crashes like me you know that while markets decline quickly, they do recover and then some. This experienced truism can keep you clear headed in what are especially important days ahead. We have crept into bear market territory. We need to be data driven in what we do next, and not let emotion creep into our decision making. It’s natural to be led by fear. Remain calm and think long term. The right mindset is everything in trying times like today.

2. Don’t panic sell. This is where having the right mindset and discipline are so important. As tempting as it may be to sell to stop the carnage, just remember “it’s not a loss unless you sell”. Looking at data going back to 1930, Bank of America found that if an investor missed the S&P 500’s 10 best day in each decade, total returns would be just 91%, significantly below the 14,962% return for investors who held steady through the downturns. Selling and then buying back in when you think normalcy has returned will result in a high likelihood of missing some or all the 10 best days that will occur over the next decade. I have held onto all my stocks and will continue to do so throughout this downturn. The exception I made is selling two stock that I had been planning to sell as I lost my confidence in them some time ago. Rather than waiting for them to further slide, as bad companies will be particularly hit hard during difficult economic times, I sold to free up cash so that I can purchase good companies that are selling at a discount.

3. Assess your risk tolerance. Major market declines like we are all currently experiencing reveal your true risk tolerance. While there are surveys you can take to try and assess your risk tolerance, it’s all theoretical. We all want to say we can take on some risk in exchange for high return but it’s only when we see our investment portfolio dip 10% in one day and 30% in a month that this resolve is tested. Being honest with yourself about your risk tolerance is both hard and critically important. Use what this market collapse has taught you about your own tolerance for risk. If you are finding it too stressful to watch your portfolio decline so rapidly, to the point where you are not able to sleep at night, just follow steps one and two for now. Over time, as the market recovers, you will want to re-consider your stock allocation and look for alternative assets that will not be as volatile. Do not make these adjustments now as you will be essentially locking in significant losses that will take a long time to dig yourself out of. This too shall pass. If you find yourself able to tolerate the short-term pain and you can take on the risk knowing the rewards will come, continue saving and investing as you normally would. If you can free up additional cash, or have smartly kept some cash on the sidelines for times like this, follow the legendary investor Warren Buffett’s advice:

“Be greedy when others are fearful”

Today’s market conditions, and what may follow in the months to come, is exactly what Warren had in mind when he offered this sage advice. I’m certainly acting on it, but there is a method I’m following rather than indiscriminate buying. Read on to learn my game plan.

4. Sell some fixed income investments to free up cash for buying stock. While not for everyone; I personally sold some bond funds recently to have cash at my disposal for buying great businesses on sale. I believe market crashes like we are currently experiencing happen once a decade or so, you can either retreat or you can embrace the opportunity to buy those companies you’ve always admired but were just too expensive to buy. My plan was always to re-allocate some fixed income investment capital to the stock market when the next crash arrived. Now that we are here, I have a significant cash position and stand ready to execute my plan.

Let me be clear, I intend to build my bond allocation back up to be commensurate with my risk tolerance and life stage. I will do this slowly but surely. I am a big believer in proper asset allocation and recently wrote about how to build your perfect portfolio to optimize returns and minimize risk. These are unique times and I have decided to act to be on the right side of what could end up being one of the largest wealth transfers in history.

5. Buy great businesses at a discount. You know those amazing companies that you have been kicking yourself for not getting in on earlier. Where the price was so expensive that it stopped you from buying. Well, dust that list off. Times like this are when investing careers are made. When you take a three to five-year horizon you will realize that there are many companies today that are getting unfairly penalized because of the COVID-19 pandemic and the recession that will likely follow. In fact, some companies stand to gain more customers due to the unique societal circumstances the pandemic has created. Streaming providers like Netflix that fill countless self-isolation hours with entertainment, and technology providers that enable remote working such as Zoom, all have an opportunity to add subscribers.

6. What to buy. I’ve started to build a watchlist of stocks that I’m interested in buying, at the right price, over the coming months. I’ve grouped these companies into two categories. It’s not an exact science, there is likely overlap.

• Resilient companies: Stock price declines for these companies are likely not as steep because they are well positioned well to come out of the bear market stronger. They are not seeing as much interruption to their operations due to the pandemic, and thus likely will experience limited impact on earnings. Think Netflix, Costco, and Amazon. As you get into small cap companies, you will see more volatility and thus steep price declines, despite their resiliency. This is because small cap companies tend to attract individual investors that are more likely to act in the short term, versus the institutional investors that favor large cap and think long term.

• Down but not out companies: Price declines are steep because the economic impact of the pandemic are expected to be severe for these companies. These are companies whose operations are being severely impacted, and therefore will likely experience more significant earnings impact over the next few quarters. Despite the turbulence ahead these are still great companies that will thrive when it’s safe for us to return to our regular lives. Think Disney, McDonalds, Starbucks.

With both types of companies, I’m looking for market leaders that have little to no debt, or easy access to capital. Companies that have both qualities will emerge with greater share and dominance in their markets.

Resilient Companies:

The criteria I’m using for screening “resilient companies” are:

• High recurring revenue: This can include companies that generate significant portions of their revenue from subscriptions, or those that have very loyal customers who tend to buy their goods and services on an ongoing basis via membership or loyalty programs.

• Mission critical: These are companies that businesses and the government cannot operate without (e.g., Workday, Amazon Web Services), or consumers cannot live without (e.g., utilities, consumer staples, grocery stores).

Here are the resilient companies on my watch list. I am not recommending purchase of these stocks; you should do your own research:

· Amazon

· Service Now

· Alibaba

· Costco

· Netflix

· Square

· Shopify

· Mastercard

· Visa

· JD.com

· Twilio

Down but not out companies

The criteria I’m using for screening “down but not out companies” are:

• Compelling valuation

• Competitive advantage (e.g., strong brand, culture, technology)

Here are the down but not out companies on my watch list. I am not recommending purchase of these stocks; you should do your own research:

· Disney

· Starbucks

· Coca Cola

· Luckin Coffee

· Sherwin-Williams

· Union Pacific

· Pinterest

· Store Capital

· Roku

- TradeDesk

- Markel

- Facebook

I am also looking at dividend aristocrats who I believe have compelling valuations and can sustain their dividend. Three dividend aristocrats I’m looking at include Cincinnati Financial (CINF), Realty Income Corp (O) and McDonalds (MCD).

Be cautious. There are some dividend paying companies that suddenly have very juicy dividend yields (e.g., Boeing) that I worry will need to significantly cut their dividend.

I have a checklist I use for finding winning stocks that I’ve been using a lot lately.

7. What I’m not buying. There are some industries that I’ve decided to avoid during this crisis because I believe they will get permanently disrupted as a result of the pandemic. It’s too hard to pick the future winners in industries that are undergoing such massive change in real time. This includes the airline, cruise, hotel and travel industry in general. For other reasons I continue to avoid oil and gas altogether.

8. Don’t try and guess the bottom. This is impossible. The stock market is forward looking. It will price in expected economic outcomes into today’s stock prices. That could mean the likely recession that will occur has already been baked into today’s lower prices. Or, another shoe could drop and the current economic outlook may be way off.

You don’t want to get sitting on your hands, waiting for the perfect price of a great business. Holding out for another few percentage points to hit your perfect price doesn’t make sense. The stock may never drop to your “guessed” floor and you end up missing out on owning an amazing business at discount.

To combat the volatility in the market and avoid catching a falling knife as much as I can, I have employed a Dollar Cost Averaging (DCA) strategy. DCA is a strategy where investors divide the total amount to be invested across periodic purchases of a stock or set of stocks. For example, rather than investing $8,000 into my favorite stock all at once, I would invest $2,000 every week for the next four weeks. I plan to employee this strategy over many months, not just the next month.

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These are scary times. But we are resilient and will come through this stronger. I hope by sharing my personal playbook for these frightening stock market conditions it will give you pause to think clearly and long term.

Be safe.