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Is the Coronavirus a Black Swan?

Is the Coronavirus a Black Swan?

| January 28, 2020

Happy Chinese New Year and welcome to the year of the Rat! For those of us in the United States, we may follow the solar new year and it's easy to miss the celebrations. As you may have heard, celebrations in China have been muted thanks to the outbreak of a new, deadly virus coming from the town of Wuhan.

The details are emerging fast and furiously as I write this, but it seems that livestock markets where bats, koala bears and black swans were sold for food created perfect conditions for the coronavirus to proliferate and spread. The Chinese government is working to build hospitals and sequester its people, locking down cities with over 14 million people. For perspective, that's about the size of shutting down New York and Chicago at the same time. With almost three thousand infected and 81 dead, those numbers are expected to increase.

The question is "How do you modify your financial plan in light of this news?" I'd like to offer you two answers that seem contradictory at first.

Step One: Don't Make Any Changes
Do you remember SARS, Ebola and the Zika virus? What impact did those potential pandemics have on the markets and the economy? Chances are you don't remember. Not to worry, we've got some information from Dow Jones Market Data below:

What you'll see here is very little useful data. In other words, past outbreaks don't give us any clues to how the next 6 or 12 months effect the S&P 500. Furthermore, we can't say what myriad of factors are causative to performance and what are mere correlation or even coincidence. Using epidemics to time the market is a fool's errand.

By late January 2020, we've already had a slew of potential bad "news."

  • The President of the United States has been impeached by the house and is being tried in the Senate.
  • Iran and the US are ratcheting up tensions in what the media is touting as a prelude to World War III.
  • Non-financial corporate debt is at an all-time high, as I've written about here.

And now with the coronavirus and the impact on the global economy, we ask ourselves, is this the straw that breaks the camel's back? The key is that we don't know and can't know. Reacting to the economic and geopolitical news is not an effective strategy for managing your portfolio and making forward-looking financial planning decisions.

Step Two: Make Change Part of the Plan

Let's be clear that I'm not advocating a passive, set-it-and-forget-it approach to retirement readiness. The closer you get to retirement, the more dangerous volatile markets become. The reason is that withdrawals from your portfolio put you at the risk of sequence of returns. We advocate an approach that takes volatility into account.

First, we set up a bucket for your near-term liquidity. If you are building towards retirement this could be three to six months of living expenses in FDIC-insured bank accounts. If you are closer to retirement, we might want a years worth of income in this bucket.

If you are ten years before or after beginning withdrawals from your retirement accounts, we would also set up a second bucket for the income you will need soon. This account would be focused on income and be conservative in nature. Finally, we'd set up a third bucket for long-term growth. We know that inflation will mean a higher income need in the future, typically ten years from now. In our third bucket we'll grow your funds.

In that long-term growth bucket, we'll create a portfolio based upon your risk tolerance. Keep in mind, this money isn't for income now, it's for growth later. This allows you to sleep at night knowing that you've got time for it to grow, but also recover from downside market volatility.

Volatile markets are difficult to predict, but we can use technical indicators to make disciplined tactical adjustments. So your plan should be set up to make changes based upon your risk tolerance, goals and market conditions.

The Next Black Swans

Unforeseen, unpredictable events are often called Black Swans. In hindsight, we look back and realize that we were caught unaware by events that nobody predicted. In the economy, the terrorist attacks of 9/11 are considered a black swan event that caused the stock market crash and economic slowdown that followed.

After 11 years of economic expansion, stock market gains and Federal Reserve generosity, we would be wise to plan for a visit from the next black swan. We don't know what economic or geopolitical form the black swan will take. We only know that we have to have a plan that is expecting it. Doing so can help us respond appropriately to both good and bad news.

If you'd like to discuss your financial plan and the next Black Swan, click here