A Market Update

My most recent updates to my clients. 

 I want to send along an update given that markets have continued their recent sell-off.   The major indices I follow are down anywhere from 7-12% since my letter in late April.  Many know I’m originally from a small town in Indiana that borders with Ohio.   My father was a lawyer there whose clientele were mostly folks like many of my clients today.  He gave me an invaluable piece of advice which was to be forthright with people.  Give them the news straight out, both good and bad.  I’m going to do that today just as I've done through other market declines over three decades of investing money for clients.  I’ll only briefly note why we’ve come to this moment.   The uncertainty from Covid’s supply chain disruptions, aftershocks from the virus itself, the Federal Reserve’s attempts at fighting inflation as well as the war in Ukraine caught investors offsides in terms of current realities versus original expectations for the coming months.  Markets typically sell off when that happens.  This time has been no exception to that reaction to bad news. 

 

The winter months saw some damage to portfolios.  However, the selling has picked up in both intensity and consistency in the last six weeks as economic expectations have become less optimistic.  I follow 20 major market indices and they’re on down on average 24% this year.  Much of these losses have occurred in the past six weeks.  It’s worse for many individual stocks.  I saw a recent statistic noting that 50% of stocks in the Nasdaq Composite are down 50% or more.  Even bonds have been no help.  You have to go back decades to find a period where bonds have performed this dismally.  I’m trying to illustrate that there’s been no place to hide except for cash.  Generally speaking we have above average cash holdings in client accounts, but it’s never enough to blunt losses when markets slide like they’ve done so far in 2022.   

 

I want to briefly discuss my investment approach as I think it’s important to have this backdrop with what I need to say in the rest of this letter.  I work with Exchange Traded Funds {ETFs}.  These are diversified indices that are low cost and tax efficient.  ETFs offer many advantages, but they will track in the same manner as the underlying index they follow.  That means when markets go down, your investment in these will also trade lower.  However, there are ways to mitigate some of that risk, say by having cash.  Diversification within a portfolio also helps.  To do this I spread out my investments per client profiles in various strategies.  These buckets include strategies that invest in major market indices, strategies for total return, strategies for investing in international markets and as well strategies for investing in individual sectors.  Investing for total return and internationally has helped this year as in general these ETFs have overall performed better than major US investment indices.  However inn markets like these, everything goes down.  It’s just that some parts go down less.  Now let’s discuss where I think we go from here. 

 

Being straight with you is me saying I have no crystal ball telling me what’s in store in the near term other than I believe the news cycle will continue carry a negative slant.  March of 2020 was the last time we faced this kind of market uncertainty.  The world was different then, being the beginning of a global pandemic, but the concern and fear is similar. Nobody knows now for sure to what extent we’ll be able to slow down the economy without having a recession and the war overseas is a major outlier.  So, I’ll rely on probability my and previous experiences with bad markets.  In that vein, I want to prepare you for the possibility that markets could continue to sell off in the coming weeks.  My guess is that stocks are going to need some time to consolidate and gauge economic activity before meaningfully advancing. I think we could be trading around these current levels or perhaps a bit lower perhaps even into the fall.   

 

This decline’s different from what happened in 2020 because the economy’s growing at a rapid and inflationary clip, along with full employment.  Corporate America’s balance sheets are generally in much better shape right to weather an economic slowdown than we’ve seen in years.  Companies are starting to buy back their stock, while we’re also seeing evidence that corporate insiders are purchasing shares at a rapid clip.  Investors have also begun the process of discounting slower economic growth, higher interest rates and less than rosy economic news.  It remains to be seen how much lower markets need to trend until they hit a level where buyers find equities attractive, but with major indices significantly lower so far this year, we are likely well along into that process. 

 

It’s now reasonable to assume that stocks have declined to more attractive valuations for investors willing to look out 12-18 months.  That’s the time frame that I constantly apply to all the investments I make on your behalf.  Investors with that time horizon should think seriously about taking advantage of these opportunities because corporate America is once again becoming for sale.  On a valuation basis we are likely not as cheap as the 2020 lows, but we are in a much better position regarding prices than a few months ago.  Probability suggests there’s value being created right now in equities even as I’m telling you there’s a possibility that stocks could fall further in the coming months.  I also don’t believe we’ll see the kind of bottom that we saw a few years ago where stocks turned on a dime, headed higher and basically never looked back until this year.  You may have to sit a while on investments made now to be rewarded like you were back then.  Investors prefer immediate gratification.  Markets don’t always oblige that desire. 

 

Nobody will know when or where will be the final bottom in this decline.  That wisdom only occurs in retrospect.  It’s possible markets will continue trending lower for a bit of time.  Longer-term though, unless this time it’s very different, it likely won’t matter if we’re a bit off in catching the final low.  In 2008 you could have bought stocks in October right after that crash, been rewarded with gains through the end of the year, only to have to sit through the final throws of that bear market through March 2009.  In retrospect it didn’t matter.  Any major index you bought back then has paid off handsomely regardless of buying in October, 2008 or March, 2009 over the next few years.  I think there’s a very high probability we’ll feel that way in the coming years even if we miss the absolute lows or if we must sit a bit longer with our investments to see profitability.  Picking at assets with money you’re willing to allocate to longer-term investments as they become or remain cheap is no guarantee of profit, but the margin of error down here is much more favorable longer-term.  One last note. The evening news is likely to get worse before it gets better, but stock prices will turn before the news cycle.  That’s why I say don’t try to time this market by selling and trying to pick the bottom.  To do that means you have to be confident you’re going to know when to get back in.  I have seen that skill elude individual and professional investors time and time again.  

 

I believe the risk reward ratio for is slowly tilting towards investors.  Therefore, I think the best strategy is to begin slowly investing cash reserves at these levels and perhaps doing some rebalancing if necessary.  That’s what I’m doing with my investable funds as well as clients.  I have done some of this already depending on client circumstances and plan to apply this discipline more opportunistically as market conditions warrant going forward.  I believe it’s Warren Buffet who said to “be greedy when others are fearful”.  Well investor sentiment is about as bad as I can remember it, so I’m thinking the probabilities over time are starting to look more favorable.   I will close by making the same observation as in March of 2020.  “I’m not very good at asking clients to send my firm additional dollars to invest but I will say that if you buy my line of reasoning then I’d suggest that now is a good time to perhaps sending us money to put to work on your behalf over time.”  That call turned out to be a pretty good time to put new money to work.  Probability suggests this has the potential to be as well, as long as you can be patient and have a longer-term perspective on things.