The long awaited correction in global financial markets is in full swing now, fear is at a maximum and selling just to get out has become an investment strategy. For anyone with money in the markets, this last weekend was not fun as we ponder the possibility of wealth disappearing, of market crashes and long lasting bear markets. I know you have lots of the same questions as we’ve been through this many times in the last 25 years. Here are our answers. Feel free to pass this on to any friends or family who need some peace of mind.
How are We Positioned Now?
After selling holdings methodically in June, July and August including many of our longer term positions last week we now have the highest cash position we have carried since the beginning of the last bear market in 2008. Remaining positions held are generally in lower beta (risk) large cap stock funds, defensive sectors like consumer staples and healthcare, a few high dividend paying ETFs, alternative funds that have low or negative correlation to the market and select lower risk bonds. These are all subject to being sold as well if necessary but that’s what we still own. For this stage of the cycle, we are approaching one of our most defensive allocations of the last decade. Of course, each of our strategies has a different tolerance for market risk so “defensive allocation” is relative. Tactical Equity strategies have a higher tolerance for regular volatility as stock only programs. Blended Asset strategies carry a lower total portfolio risk by diversifying across different asset classes. And our Income models have the lowest tolerance for market risk and loss by ownership of only bonds as well as the application of our long standing market timing signals.
Below you will find our current cash positions as of the end of last week in each of our strategies organized by investment category:
New Power 57%
Worldwide Sectors 42%
High Dividend 27%
All Season 35% (+ bonds and hedges)
Gain Keeper Annuity 57%
Foundations 42% (+ bonds)
Retirement Income 84%
Freeway High Income 68%
Holding Tank 100%
For any investment strategy, this is lots and lots and lots of cash, not to mention the defensive positioning of remaining holdings. If the selling continues, we will hold up much better than the market and be in that delightful position to buy cheap stuff with our emotional and physical capital intact when a real bottom develops.
How Serious is This Decline?
This is a nasty correction in stocks without a doubt. Last week pushed many indices into double digit losses from the highs and YTD with the 5.8% hit for the week. This AM as I write, global markets are down hard (4-6%) on follow through selling in China and Europe. While the twitter feeds and short term commentary is all about black Monday, we don’t see a crash in the works as much as a continuation of the heavy and indiscriminant selling that characterized last week. Buyers are likely to emerge soon – more on this in a minute. We have been waiting for a correction of at least 10% for over two years and now we have it. I said a while ago that after such a long period of steadily rising prices and low volatility, the first real correction would feel terrible. This feels terrible but so far, we are only looking at a long overdue correction in stocks barely tagging the very “normal” 10% decline threshold that we tend to see at least once a year. It just hasn’t happened for a while so we all forget that it does happen right?
Every bear market begins with a steep correction, so let’s look at that possibility. Is this the beginning of a new multi-month, multi- year bear market that erases 50-75% of the previous bull market’s gains? Our answer is that it’s probably too early for that event given the current underlying STRENGTH in the macro economic variables. Bespoke sent out a great piece last week called “Two Lies and a Truth”. I will quote them because I couldn’t have said it any better.
“Lie Number 2:
The US is about to enter a recession.
This was, without doubt, one of the most absurd things we’ve heard in some time. A TV pundit, making claims that declining activity and currency pressures in EM Asia were going to push the United States into a new, broad decline in economic activity. If we had been the only ones watching that interview, we would find it hilarious, but instead we are just sad that there are inevitably those who might be badly deceived by yet another bomb thrower. Today existing home sales hit their highest level since 2007. The same goes for housing starts, out earlier this week. Jobless claims are near 40 year lows, even without adjusting for a drastically larger population and labor force. 2.9 million jobs have been added in the last year, at a growth rate of 2%. Workers are receiving raises as measured by median wage trackers or our analysis of what the Employment Cost Index says about blue collar workers. Auto sales are sitting near all time highs. Consumer debt is falling as a percentage of income and debt service payments as a percentage of disposable incomes are at all time lows. The government deficit is narrowing, banks have been recapitalized and deleveraged (and are lending at robust rates), and consumer confidence sits near post recession highs. All of this has come, once again and we emphasize, with declining debt loads for the households that create 70% of US GDP through consumption.”
Bespoke Investment Group, LLC July 20th, 2015
Given the long list of strong macroeconomic conditions and lack of recession risk in the system, it would seem most likely that this decline proves to be a very steep and painful correction that finds buyers early taking prices back up toward to the highs of the year. We are not married to that outcome by any means, just expecting it. Remember, the Federal Reserve is on tap to raise rates because of the strength in the economy – not weakness! We’ll be very watchful of the strength of that rebound which should start soon to indicate whether we expect a more protracted bear market ahead or all time new highs ahead.
With that said, considering the real weakness in China and now Europe economically, as well as the real wealth destruction in financial markets, we see the chances of a September rate hike by the Fed as slim to none. If the US economy can continue to chug higher for the remainder of 2015, we could see a December rate or more likely a 2016 rate hike but those are now the first opportunities for the Fed.
What is Our Strategy Looking Forward?
As you might imagine, we’re not in a hurry to buy anything here. I was pleasantly surprised to hear from several of our younger clients over the weekend asking if they should buy stocks now? My advice was this. Do not buy anything yet but get yourself in a position to do so now meaning feel free to add cash to investment accounts, identify money that you want to add to investment accounts, make retirement contributions or 529 contributions (to cash) as desired – See Calling All Cars Below for a more specific recommendation. Our approach now looking forward is to carry current cash, potentially raising it slightly again if any rebound proves to be weak and short lived. In the very short term (next week or two), we’re going to grind it out as markets are now at extreme oversold levels. Statistically, within two weeks, we should see prices higher by 2-3% from where they are today. Of course that rebound is likely to come from a lower level meaning it could be very strong.
As I said in the past many times, investing is a game of probabilities. Today we have an extremely oversold market that is experiencing a near waterfall decline. This hurts and we all want to have everything 100% in cash. Perhaps that is the right choice but the probabilities are strongly against it. Strong investors will be making a shopping list of things that are holding up better than the market (hard to identify now) possibly even buying a few things. Weaker investors are still looking for a way out to cut the pain. This is what creates a lot of market volatility. Weaker hands moving to stronger hands in mass. So far, the weaker hands are dominant but that will change.
Find Some Peace of Mind
If you are seeing red and can’t think straight. Do these 5 things:
1. Turn off the TV
2. Avoid reading short term headlines
3. Stop holding your breath
4. Go outside, take off your shoes, put feet in the grass for 5-7 minutes
5. Know that the US stock market is a resilient animal and there is a mountain of cash that wants to buy cheap stocks out there. Know that corrections create opportunities to make a return on your capital and we finally have an opportunity developing. Know that you will look back on this time as a dark moment and glad that the situation has improved.
Feel free to call or contact us at any time if you need to talk.
Calling All Cars, 8/24/2015
I believe this is an opportunity to add approximately 50% of your planned annual contribution to investment accounts that are generally passively held like retirement plans, 401k plans or 529 education accounts (things you can’t trade). We’ll look for another opportunity to deploy the remainder of your planned contributions later in the year. Personally, I will be adding 50% of my annual 529 contribution to my kids’ accounts in the next few days. That money will go to my current allocation directly which is 75% “Growth” portfolio and 25% cash as it has been for over a year now. My kids are 13 and 11 just for reference so they won’t need their education money for at least another 5-7 years. I share this as an example of how you might add to your investment accounts. Please feel free to call or contact us if you need help with your individual situation.