News started rolling in this past Sunday of Aramco, the Saudi Arabian state oil company, cutting oil prices. On top of that, it pledged to increase production of oil. This will certainly have a significant impact on both commodity and financial markets. In our first Insight Extra of the year, we discussed OPEC’s reduced ability to influence energy prices. We are seeing a reflection of that here. This cut is perceived as the first major salvo in a potential pricing war between Saudi Arabia and Russia.
Market reaction to this development will likely be significant. This new development comes as the market continues to grapple with the effects of COVID-19 (coronavirus). Year-to-date we have seen drastic reductions of oil prices. We have experienced periods of uncertainty. We have endured periods where equity markets have traded down significantly. A relationship we have seen, and expect to continue to see, is the resilience of markets after major downturns. We see an upward sloping line when we look at a graph of S&P 500 Index returns. We see periods of slowdowns and downturns, but for the most part, the graph slopes up.
To reinforce this point, if you had gotten into the equity market at its 2007 peak, before the financial crisis, you would be up close to 150% as of February 28 of this year. If you were prescient and invested at the bottom, you would be up 400%. If you moved away from your allocation and went to cash, you would have missed out on these returns, which could have significantly impacted whether you achieved your financial goals.
As human beings, we are very sensitive to pain and loss. So sensitive that we usually are more averse to a loss than to a gain of the equivalent amount. That is to say we feel the impact of a loss of $100 more than a gain of $100. This increased sensitivity to loss is called loss aversion and has been studied exhaustively by cognitive psychologists and behavioral economists. This bias leads to the likelihood of investors overreacting when a loss seems imminent. This reaction outside of the stated plan or strategy has led to many investors missing returns and significantly negatively impacting their ability to achieve their financial goals.
The appropriate asset allocation considers market downturns as well as upside potential returns. The appropriate allocation based on the goals, risk tolerance and time horizon of the investor withstands the storm better than reactionary changes to allocation.
Contributed by | Kuuku Saah, CFA, Managing Director
Kuuku is a Managing Director at BTC Capital Management with nine years of investment management experience. Kuuku’s primary responsibilities include portfolio management and analysis. Kuuku attended Drake University and double-majored in finance and economics. He is a holder of the right to use the Chartered Financial Analyst® designation.
Source: BTC Capital Management, Bloomberg LP, Ibbotson Associates, FactSet.
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