Hansel and Gretel is one of the classic fairytales from the Brothers Grimm.
We all know the story— children, neglectful parents, witch, oven … a trail of rocks (and to the children’s downfall, breadcrumbs).
It has to be said—the stock market is the real-life Witch of the current narrative ….
We always lean on our process during markets such as these. We started reducing risk to the stock market about a month ago and continue to remain on the defensive until we see things have settled down a bit.
Here is what our risk management process has dictated:
- Raise Cash. During the first bout of volatility our risk management process has us raise cash in our equity models. The same goes with our Blended Asset portfolios but to a smaller degree (if we have other things to buy). That happened last month. Current cash levels are between 18% and 40% depending upon the stock model. As an aside, we’ve also raised cash on the Income models as several of our positions have hit our targets (High Yield Munis and some US Treasury positions). We are always eager and willing to put cash back to work; we just need to see more evidence of a “durable” low and have things to buy in order to do that.
- Buy Non-correlated and Lower Beta Assets. We are always on the lookout to buy assets that don’t necessarily move with the stock market—or at a minimum, move less (lower beta). Things like real estate, convertible bonds, gold, silver, preferreds, etc. We’ve added these assets to our Blended Asset models and in our High Dividend model.
- Buy Hedges. When there is little to no opportunity in the stock market, as has been the case the last month, we will use hedging. We currently have a hedge on in small cap US equities to help soften some of the volatility in your portfolios. Most times, these positions are short-lived but in extreme cases it makes sense to use them in order bridge the gap to getting to better value.
- Sell Low Quality Bonds and Buy High Quality Bonds. This means avoiding US high yield corporate bonds. We reduced this weighting last year (early) but are glad to be in investment grade, US government bonds, and cash during these types of moves.
- Look for Relative Strength to Buy. This is always the final swing for us. Ultimately, we want to be invested earning excess returns above cash. We screen our investible universe every day. Not there yet, but hopeful we reach that point some time in the 2nd quarter. Patience is key.
These bouts of selling create opportunities. The key is preserving as much capital as possible until value starts to show up. If we can preserve capital during these selloffs we don’t fall prey to the ill effects of negative compounding—i.e. having to dig out of a very large hole.
As always, we are following our process, and we are on the lookout for the trail of rocks to lead us back home to being fully invested (before this witch of a market throws us in the oven!).
We just aren’t quite there yet.
We’ve managed markets like this before and our confident that our process will win out in the end. Patience is generally required, but when we get the go-ahead, we will actively deploy cash at presumably much better prices.
If you have any questions / comments, please feel free to reach out to us.
Enjoy your weekend!