I did a mid-month market update for clients (and select prospects) where I made the case that the rally we have seen in July and the first half of August was doomed to fail and was purely a “rip your face off” Bear Market rally.
Unbelievably, the bulls kept pushing the markets higher trying to front run the Fed. They were not rewarded as the Fed’s focus remains on taming inflation. Fed Chair Powell put the markets in their place in a rather short and pithy, eight- minute speech from the Jackson Hole Summit. The markets tanked, thereafter, with the Dow Jones Industrial Average down more than 1,000 points on the day dispatching the bulls and sending them home licking their wounds.
So where do we go from here and what is your best course of action?
So far in 2022 the peak to trough decline through June was -24.5% for the S&P 500 Index. We have since gained about 60% of that back in July and August. As a next step, it would make sense to me that we should at least retest the June lows. It doesn’t mean we will, but that would be an absolute in my mind if I was pulling the levers of the markets.
Historically, speaking a -24.5% Bear Market decline would be the smallest of the past 100 years of Bear Markets. It is possible, but given all the intervention, quantitative easing and zero bound interest rates of the past decade, is a decline of -24.5% really what you would expect? I personally am looking for at least the average decline of the past 100 years (or roughly -35%), if not much more.
The market declines much faster than the time required to push it higher, but it is still a process. This means we will have bounces along the way lower in a Bear Market, like the July/August bounce. Over the past two Bear Markets, we had at least 7 bounces that retraced 50-70% of the prior decline. There will likely be many such bounces (both large and small) on the way to the ultimate market bottom. We also believe a retest of the recent June lows seems probable and then the market will likely spend some time testing that level.
We believe we take out those lows, but that is just a guess at this point. One thing I am certain is that the markets will be more volatile and will ebb and flow in whatever direction the market is trending at the moment, which at this point is down. It is highly unlikely that we will just grind higher (or lower) like we have seen over the past decade when the Fed was providing the markets with ample liquidity. In fact, the Fed is removing liquidity from the markets which means they are more likely to grind lower than the higher.
It will be very important in the decade to come to have a steady hand on the rudder of your investments to navigate through the coming storms including rising rates, inflation, supply chain constraints, the redevelopment of key manufacturing capabilities here at home, demographic changes and more that we just have just not seen over the past 75 years of U.S. protected global trade.
So now that I side stepped, going too far with my market forecast, let’s discuss the actions you can take to assure you prosper now and, in the future, to come.
First, you need the right advisor. One that excels at protecting and growing capital in tough markets and one that can assist you in planning for such contingencies so that you reach your financial goals. Of course, we are biased, but we believe we are such a shop.
Second, cash is King. It has been unfashionable to hold cash over the past decade or more, but right now cash is your best bet as an asset class as we enter a recession here and abroad. Hold whatever makes you feel comfortable right now and sleep well at night! However, be prepared also to deploy it at the right time. Don’t be lulled to sleep holding cash for the long-term as it is still likely to earn you less than the rate of inflation, which means it is losing purchasing power.
Third, the absolutes of the past decade are now gone. No one really knows when the markets will bottom or if it is really a bottom until some time has passed. Therefore, you need to resort to some tried and true methods to both deploy and protect your capital. I wrote a post in May 2022 on Dollar Cost Averaging in Tough Markets. This is one such method to manage risk while also not guessing at market bottoms. Get used to averaging into and out of markets in the years to come. They will be more uncertain!
Third, you need to be more diversified. The days of the 60% equity and 40% bond portfolio are behind us. Care to guess the top performing sector for the year? You guessed it? Energy.
After years of underperformance, energy is now only 4.78% of the S&P 500 Index vs 28% of the S&P 500 in 1998. This means a passive equity fund plus bonds gives you only limited exposure to the top sector of 2022. With our clients, we have added alternatives allocations that include top sectors, commodities, currencies, metals, and liquidity trading managers. Bottom line, you need to diversify to broaden your exposure to both profit and protect capital in this kind of market.
Finally, seek out the cash flow generators. There is an old saying that a “Bird in hand is worth two in the bush.” That saying is very apropos today. We believe it is better to get paid cold hard cash than to wait on growth that may not materialize in the future. High dividend companies pay you today and they have more reasonable valuations vs. their growth stock peers. Guess what is the top paying dividend sector by percentage today? You guessed it energy.
Let us know if we can help you today.
Have a great Labor Day Weekend!