Taking losses is painful, especially in the short term. Emotions run high. Sometimes there is even a physical reaction as we extrapolate the worst. While we don’t like losses any more than you do, market moves, like we have seen the last couple weeks, do create some tremendous opportunities for us. Our portfolio approach tends to have us lose right along with the market for the first 5-10% decline as we raise cash. We raise the cash for a couple of reasons: 1.) to soften the blow should things get worse from here; and 2.) to allow us to take advantage of opportunities should volatility subside. As always, we will adhere to our process, scope out the opportunity, and react further as needed.
Here are several things on our radar after a tough couple of weeks:
- There are a host of indicators that are signaling that stock markets are now oversold. Markets rarely move in a straight line. There is an ebb and a flow to them (sometimes more ebb than flow). We think there will be an opportunity to pick up some broad stock exposure over the next several months. In some cases, non-US markets are down 20-30% over the last year. US small caps are down almost 20% off their highs. Valuations and expectations have been reset to where we think it makes sense to add some of this exposure.
- Sector rotations have been occurring the last two weeks. Technology, industrials, and energy—the sectors that had been leading the last year—have given way to utilities, consumer staples (household goods, etc.), and some precious metals miners. The market is no longer strictly rewarding growth. The companies that we generally gravitate towards—the ones with more stable balance sheets, cheaper valuations, dividend yields, and cash flow-- should start to outperform again. The hope is that these companies should perform well, no matter what the overall market is doing.
- We use international stocks in our asset allocations, including emerging markets, which offer up the possibility of excess returns over time. That said, until a couple weeks ago, US stocks were really the only game in town. But, that appears to be changing. On average, US stock markets are still one of the more fully valued markets out there, and in certain stocks and sectors, valuations are at outright extremes (think FANG—Facebook, Amazon, Netflix, Google).That really is not the case in emerging markets right now. Most are trading very cheaply based on their growth prospects, and once the dust settles, emerging markets are certainly a place that looks attractive. China, Brazil, India, and some other Asian markets look good given the valuation, demographics, and shifting focus of their economies. We plan on using country and regional ETF’s to establish these positions.
- Bonds have offered little to no help despite the volatility in the stock market. In fact, broad bond market indexes are down for the year. We think that may be changing. There looks to be an upcoming opportunity to own high quality bonds, namely US Treasuries and parts of the municipal bond market. There may even be an opportunity to own investment grade corporate credit once this selling cycle ends.
- Commodities still offer some value. Those markets tend to move independently of the stock market and offer up protection against unexpected inflation. We will continue to maintain an allocation to broad commodity indexes in our Blended Asset strategies and may even add a position in precious metals.
During these bouts of volatility, we really lean on our process. We monitor a blend of fundamentals, sentiment, and technical indicators to assess how much risk to take. Part of that process is trying to judiciously buy discounts in markets or securities that fit our criteria. It is a bit scary, but a necessary part of trying to deliver returns. Every cycle is a bit different, so short-term results can certainly vary. Our goal is to position portfolios in the geographies, sectors, and companies that can offer outsized returns over the long run with a lower draw down profile. When we can’t find much, we stay in cash. We won’t avoid losses in all market declines, especially from all-time highs, but if we can side step the deeper losses, we will be able to compound wealth at a much higher rate.
Sean Powers, Chief Investment Officer