Dec 21 2018
Until recently stock indexes traded within normal correction territory – demonstrating more than normal volatility. However, as of late, global stock indexes have declined beyond correction levels and sectors of the market have fallen into what we consider bear market conditions.
Investors would be wise to pay attention to this greater than normal decline in stocks, as it may very well be the precursor to a continued downward spiral.
I have been a seller of stock for the past few months, which has reduced my stock exposure significantly. Most importantly my selling was focused on the banks, technology and industrial companies – which have fallen the most in this recent selloff. Thankfully this reduction in stock exposure – and of the most vulnerable stocks – has and will continue to protect my portfolio should the market decline become more significant. Keep in mind when the market falls 5%, your total portfolio declines less due to these changes and our active risk management. So where do we go from here? Have stocks fallen enough? Let’s discuss.
In many ways the stock market is the economy. Though the past four quarters of economic growth have been stellar, the stock market is telling a different tale about the year ahead. This different and less bright future is tied to many issues including the Federal Reserve and their unwillingness (at least so far) to slow or halt interest rate hikes, tariff concerns, and geopolitical and global economic debt levels.
From my view, the stock market is beginning to discount one of two scenarios. Here are those scenarios and how we expect to get you through each successfully:
The global economy slows from recent 4% growth to 1.5-2% growth and avoids recession.
This scenario would cause corporate profit growth to slow – particularly for companies that require a fast growing economic backdrop: think banks, tech, industrial, energy and consumer discretionary companies, most of which I have sold in the past few months.
However, a slower economic climate would allow a bull market of another kind to emerge – one I have discussed in recent Strategy Updates. It would be a bull market not led by the FAANG stocks, or the fast growing consumer discretionary companies etc., but rather companies in the sectors that have great profit growth regardless of the strength or weakness of the economy – think consumer staples, healthcare, utilities and select technology companies whose fortunes are not tied to strong economic growth.
This is where the bulk of your remaining stock exposure lies today and so far these stocks are holding up quite well. If this type of “new” bull market can emerge in the next few weeks or months, I would be adding more of these types of great companies such as Proctor & Gamble and NextEra. Basically, companies with great balance sheets and brands that investors can be very successful owning should this scenario play out.
The global economy falls into a recession.
At a glance, global stock markets appear to be discounting a recession. All of the sectors that typically fall the most in a recession are doing just that. It is possible that the Federal Reserve has already raised interest rates too much and instead of trying to slow the economy in 2019, it may be headed to a screeching halt.
The last interest rate hike earlier this week may have been the “straw that broke the camel’s back.” In this scenario, we want to shed all stock that would be negatively affected. The good thing about recessions and bear markets is that they are rather short affairs. In fact, bear markets usually last just 6-9 months in which case we are already two months into this one.
Should we enter this scenario, I suggest keeping your stock exposure much less than normal and in the kind of stocks that survive a tough economy. I would also buy short term fixed income and preferred money market funds to provide you with the best risk-adjusted return possible. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so.
As you know, I take risk management very seriously. Always remember the “ugly math” – when investors lose 50% they have to go up 100% to get even! Continue to use stop losses on the remaining positions in your portfolio.
In the current environment, continue to play it “safe” rather than end up “sorry.”
I wish you a safe and Happy Holiday Season.
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Oct 10 2017
I can understand why most investors questioned the viability of rising stock prices last year, given that it coincided with the surprising (to most) election of Mr. Trump. The initial rise in stock prices, referred to last fall as the “Trump Bump,” has seemed to take on a life of its own despite Trump’s inability to get anything done on Capitol Hill. Today’s doubters are understandably under invested and paying dearly for it. Years like these don’t come often. If history is a guide these doubters will eventually capitulate and embrace the steady rise in stock prices for one main reason: the recovering business cycle and increasing corporate profits support higher stock prices.
Though the earnings recession and market decline of 2015-16 was unusually mild, it did constitute a bear market and recession in our book. This very well may be another point of confusion for the average “doubting” investor who thinks that this bull market started in 2009 and is the longest bull market in history. The doubters need to recognize that the prior bull market ended at the 2016 low and we are at the beginning of a new business cycle and not the end of an aging one. One can simply look at the impressive and broad recovery in earnings growth across all economically sensitive sectors and almost all regions of the globe – it’s the real deal and it’s a great time for you to be a global investor.
Lastly, I would like to point out that although Dow 22,000 sounds high, it is not overpriced relative to earnings. Moreover, foreign markets are even less expensive relative to earnings. As global corporate profits continue to advance, markets will support even higher stock prices and a higher Dow Jones Index than one might imagine. Of course, as markets continue upward the doubters will, over time, become more fully invested – which in turn will drive stock prices higher. Nothing lasts forever, but we would suggest that we are at the early stages of better times to come. The first year of business cycle recoveries typically result in big stock market gains (just like this one) and in subsequent years returns normalize in the 8-12% range, hence the importance of being involved early.
Though I am optimistic, I do expect the normal 8-10% corrections along the way upward. Investors haven’t seen one of those in over a year and should prepare themselves for the likelihood of a return to more normal volatility. Additionally, I want you to know that within my optimistic view, I am very aware that we are dealing with the unknown and that it is a risky world. Therefore, I suggest to continue to employ my Active Risk Management tools such as having a flexible approach to your portfolio’s asset allocation, sector management and the careful placement of stop loss orders on the economically sensitive areas of your stock portfolio. All of which can be found in my book.
I hope you find this update helpful.
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