How We Think You Should Consider the 'Coulds'

Financial news headlines have run the gamut lately, but many that seem to draw the most eyeballs share a commonality: the operative verb is “could.” Some are good coulds. Some are frightening coulds. Even the most careful critical thinker could have a hard time sifting through the flotsam and jetsam to determine what is most meaningful for stocks. An easy place to start, in our view: Remember that markets move most on probabilities, not possibilities. The word “could” renders a theory squarely in possibility-land. Just because something could happen doesn’t mean it is likely to happen.

The array of possibilities we have seen thrown around over the past several days is dizzying. The IMF and others warned COVID-19 could reduce living standards indefinitely, with social distancing required until there is a vaccine—potentially years away. If ever: Some speculate humans could never get lasting immunity from COVID, or the disease could circulate near-permanently, crippling the world economy indefinitely. Others argue fear of infection could keep people in self-induced lockdown even when governments let businesses reopen. Or reopening could happen too gradually to kickstart a recovery. The ongoing civil unrest in several metro areas has prompted many to speculate that these impromptu mass gatherings could be the catalyst for a COVID second wave—and another round of lockdowns. Others focus on the economic impact of looting and property damage, warning it could be a devastating second sucker punch. Even under a rosier scenario, where businesses reopen quickly, some warn prolonged mass unemployment could permanently alter people’s shopping habits. Compounding that, many suspect extra Federal unemployment benefits could incentivize furloughed employees to stay out of work, adding an economic headwind. We have seen many a headline warning a lack of international travel could kill airlines and tourism-reliant economies. Elsewhere in the “reopening is no elixir” category, we hear millions of small businesses could close permanently, cementing an L-shaped recovery. Or a wave of bankruptcies could slow the recovery and wreck corporate bond markets. Last but not least, at least one headline daily warns the economic damage could last for years without additional financial assistance from the government.

To be fair, there are also some positive coulds. With pharmaceutical researchers fast at work, some suggest we could have a working vaccine by autumn. Even if that doesn’t happen, some medical researchers think COVID could fade away like SARS (also a coronavirus) did and never return—a prominent British virologist made this very argument in a Telegraph op-ed published Monday evening, explaining why models based on the 1918 influenza outbreak’s second wave may not be the most scientifically sound. He isn’t the only one claiming COVID could fail to resurge with a properly executed reopening. Multiple researchers also claim the fatality rate could wind up being very low. We have also seen people theorize that Sweden’s less-intrusive lockdown strategy could prove correct and serve as a template for the future.

Many fine minds make these arguments. Many of them show their work in compelling ways, making the task of determining which thesis is valid a daunting one. That is the bad news. The good news? You don’t need to pick a side. In the strictest sense, all of these theses are correct—all of these things could happen. So could myriad other outcomes. A recovery could be underway. Or it could be months away. To put it succinctly, when you are in the “could” camp, the range of outcomes is literally endless.

This isn’t so different from how things normally are. At any time, the world could go an infinite number of ways, good or bad. Stocks sift through all of it by skipping over distant possibilities and focusing on probabilities. Hence, we offer our two-step plan for dealing with this cacophany of coulds. One: Turn off your preconceived notions, opinions and biases, lest you blind yourself unnecessarily. Two: Whenever you see a “could” ask yourself, is it possible to assign a probability to this happening?

For all the coulds we rattled off, we think the answer to that second question is “no.” All of it—the good and the bad—is sheer speculation. Hence, in our view, the dismal possibilities aren’t reason to avoid stocks, and the optimistic possibilities aren’t reason to get levered up or take speculative, concentrated positions.

Yet this doesn’t make the speculation useless for investors. All the chatter reflects and influences sentiment. Being familiar with all these competing theories—and observing how the masses react to them—is a good way to take investors’ temperature. Today, from our vantage point, the dismal possibilities have more traction and acceptance than the positive ones. That suggests to us sentiment remains down in the dumps, with some degree of positive surprise more likely than negative surprise. Should the positive scenarios begin gaining more favor, then that could reduce positive surprise power, potentially signaling markets are too optimistic. We don’t think we are there at the moment, but it is worth keeping an eye on.

We still think it is far too early to declare the bear market over, despite all the ground stocks have regained since March 23. Something could thump markets anew, whether a worse-than-expected second wave of COVID or another negative scenario people can’t fathom today. But without the ability to assign a probability to this, we don’t think it is wise to position a portfolio for it today. The risk you are wrong is too great. Stocks’ long-term returns include all bear markets along the way. But achieving those returns requires participating in bull markets. Therefore, for investors seeking long-term growth, we think being out of the market is one of the biggest risks out there. To take it on, we think you need a rock-solid reason with a strong likelihood of coming to fruition. “Could happen,” in our view, just isn’t good enough support.