In the last couple of weeks, we saw a stronger than expected report on inflation, which dashed hopes that the pace of inflation had begun to slow down. In response, the Federal Reserve Bank, at its regular scheduled meeting last Tuesday and Wednesday, raised short-term interest rates by .75%, the largest increase since 1994, in a move designed to show that they are serious about tightening financial conditions and bringing inflation under control. The threat of higher inflation for a prolonged period of time and the potential that an overly aggressive Federal Reserve pushes the economy into a recession has sent stocks to their worst week of performance since the beginning of the COVID pandemic back in March of 2020. For the year, stocks are now down more than 20%, and bonds are down about 12%, as measured by the major indexes for each asset class.
Our tactical stock and bond positionings have been quite conservative through most of the year, and as a result, the declines across the tactical programs are much lower than the major averages. This is what we would expect from strategies that look at the market with a risk minimization focus. Our tactical strategies came into this week with cash typically at 50% or more and defensive positions such as hedged ETF’s commodities and consumer staples making up much of the remainder of the portfolios. Our bond portfolios were also heavily in cash during the past week.
Most investors are asking two important questions at this time: Where are stocks likely to go from here, and should I buy or sell now? One thing that we know with certainty is that we have experienced similar declines over the years. Here is how stocks have performed after experiencing a decline of 20% from their all-time high.
|S&P 500 performance after closing below a 20% decline|
|Peak||Date below||S&P 500||1 Month||3 Month||6 Month||12 Month||24 Month||36 Month|
|Source: Internal with data provided by Thomson/ReutersPast performance does not guarantee future results|
The numbers are pretty compelling that historically a 20% decline often provided a good buying opportunity. However, the key is whether we avoid a recession or not, and it is also an important consideration whether stocks trade at high valuations. If you look at the cases of 1973, 2000, and 2007 (which were generally well below average in terms of subsequent return, they all encountered either a strong recession, high valuations, or both.
The question of whether we will have a recession will only be knowable in hindsight, but the risks are mounting. We only need to look at factors like consumer confidence, homebuilder sentiment and buying traffic, small business confidence, and a Federal Reserve that is intent on slowing the economy to quash inflationary pressures.
So, what should an investor do at this point?
First – Remember that declines such as this are a normal part of investing. If you are uncomfortable with the large swings the financial markets are taking, we should visit and look at your allocation across different types of investment strategies. Successful investing is about being willing to stay with your investment discipline in both the easy and hard times.
Second – Financial markets will almost always recover over time, but it may take long enough that it will risk derailing you from reaching your financial goals. Many firms that sell investments but do little to manage them afterward note that the stock markets always bounce back, and so far, that has historically been true for the U.S. stock market. However, there have been some cases where it took a very long time to make any meaningful progress for the stock market. Here are the three major cases for the Dow Jones Industrial Average:
It hit a high of 381 in 1929. It did not reach 400 until 1954.
It hit a high of 995 in 1966. It did not reach 1,100 until 1983.
It hit a high of 11,700 in 2000. It did not reach 13,000 until 2012.
These long, secular bear markets are infrequent, but they can significantly impact investors. This is why we believe that a combination of strategic and tactical investment strategies can be helpful in reducing the risk and navigating through such a long-term bear market, should it arise.
Third – Market declines such as this are when we have the opportunity to potentially find good investments at attractive valuations that may provide us with the potential to make strong returns in the future. Unless we experience something that will permanently impair the economy, the stocks of quality companies will likely recover. As investment managers, we are closely watching the markets and are ready to take such opportunities when they arise. Over the years, we have made many of our best investments during bear markets.
We have never met anyone who enjoyed market declines. It is always stressful to watch investments lose value and deal with uncertainty, but that is what we need to tolerate so we can potentially benefit from the opportunity to earn returns that can beat guaranteed investments such as government bonds or bank certificates of deposit.
We are pleased with how well most of our investment strategies are navigating the current market environment relative to the major indexes and we believe there are good opportunities in the coming months. Nevertheless, if you have been feeling uncomfortable riding through the fluctuation of the past few months, please reach out to us, and we would be happy to visit about whether it may be appropriate to make any adjustments.
We appreciate your confidence in us and stand ready to be a resource whenever you have questions or concerns.
Michael Ball, CFP®