The Bear Ate Santa Claus’s Rally

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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