As we near the finish to the first half of 2022, the market’s sustained volatility has become widely publicized. Experiencing daily moves--both up and down--of 2%, 3% and even 4% has not been unusual over these last few months. Stocks have entered their latest bear market and bonds have had their worst start to a year since the 1980’s. This increased unpredictability in the market’s direction underscores the issues facing the market and highlights how fluid circumstances can be on a day-to-day basis.
The biggest worry for the markets continues to be inflation and how the economy, consumers and businesses will deal with increased pricing pressures. In its pledge to tame inflation (as its primary mandate), the Fed has promised to be vigilant in raising interest rates. Today the Fed will have its June announcement of their intentions on rates; it is expected that they will raise rates, but whether they become more aggressive is TBD. The expectation has quickly changed from possibly only a .50% increase in rates to a .75% increase. Of course, more aggressive policies of raising rates will concern the market that doing so will send the economy into a full-blown recession. However, the markets may also welcome a tougher Fed with thinking that more rate increases may help bring inflation down sooner. The Fed continues to have their back against the wall. As such, both the bond market and the stock market have been in tailspins to start the year.
However, as noted, conditions are dynamic. Interest rates, which have moved very sharply over the last few months as investors are trying to “get ahead of” the Fed’s predicted interest rate hikes, have started to have some effect on economic data: for example, inventories are building, lumber prices are declining, the housing market has slightly slowed, mortgage demand has evaporated and new company layoffs are now being reported. These are all “deflationary” effects to the economy and should help inflation to moderate.
So, is perhaps the market doing the “heavy lifting” on allowing the Fed to be more patient and less aggressive in raising interest rates? Maybe. But again, inflation is still the highest priority/concern and until this number is showing some signs of slowing…or at least peaking, the market will remain choppy and fixated on the Fed.
Of course, while this inflation narrative plays out, China’s lockdown and the war in Ukraine continue to sit as a dark cloud over the markets. Any developments on these two situations may also affect the markets on a daily basis.
We’ve finally seen all the speculative and overvalued areas of the markets have their bubbles burst, but there haven’t been too many other places to hide out. We’ve already heard about some big hedge funds having problems and it is probably a fair assumption that there are a lot of over-levered investors forced to sell. Once again, the markets are teaching the speculators a lesson.
Top 5 Ways to Tackle a Bear Market
When markets become volatile, sometimes the “advice” is to not look at the daily valuation changes in your portfolio or to avoid looking at your investment statements. While we would agree that removing emotion from investing is essential to generate good long-term rates of return, we would certainly not agree with the stick your head in the sand mentality. Here we share a few essential factors in managing investments during a bear market.
- Build a robust portfolio – most people are familiar with portfolio diversification, owning both stocks, bonds and maybe alternatives in your portfolio to provide different risk/return parameters and to smooth out the volatility. We take this one step further in the portfolios we manage and are looking to build ROBUST allocations for our clients. What does that mean you ask??... In our opinion, a robust portfolio is built by first considering the outlook for many factors including corporate earnings, valuations, GDP growth, interest rates, recessions and inflation to name a few. Next, we want to make sure we are well diversified beyond just the S&P 500 or the very popular “total index” funds. Investors are learning the hard lesson this year that both the total index funds and S&P 500 funds are pretty much the same thing-a US large cap growth fund. These should certainly be core pieces of an equity portfolio, but not in the least is this a diversified portfolio. Investors still seem to forget the lost decade where the S&P 500 returned zero for the whole decade while small caps, value, and international stocks performed quite well. In our view most investors are not diversified enough within their equity allocations.
- Find buying opportunities – it sounds so simple, right? How do we know if an individual stock, sector or index is “on sale” and may present a good buying opportunity? We can look at a few different metrics including the share price, company earnings, revenue & debt levels to start. Basically, if the company’s earnings, revenue & debt levels have remained constant and the share price of the stock has declined you MAY have a buying opportunity. One easy way to review this is to look at a stock’s Price/Earnings ratio, which is found by dividing the share price of the stock by the earnings of the company. For example, if a stock is trading at $100 per share and has earnings per share of $6, then the P/E equation is $100/$6 = 16.7. When we buy a stock, we are paying for the FUTURE earnings of that company – the higher the P/E ratio is, the MORE we would be paying for future earnings. In the example above, you would be paying about $16.7 for $1 of earnings. So, we must not only look for buying opportunities from a valuation basis, but also make sure that the investments we are buying are positioned to do well in the future, as we discussed in our point above about having a robust portfolio.
- As an investor, make sure you are looking through the windshield and not the rearview mirror to navigate… It is very common for investors to fall in the trap of chasing returns. When a particular investment or asset class posts very good returns, we find that investors may add capital to these positions rather than adding capital to investments that have not done so well or may have even lost money! Take for example the U.S technology sector (Nasdaq Index) which posted returns of 21.39%, 43.64% & 35.23% in 2021, 2020 & 2019, respectively. During that same time period, investors added approximately $42.5B to the Invesco QQQ ETF, a popular index fund that track the Nasdaq 100 Index, with about 50% of the contributions coming in last year. What happened to that same index this year? It is down about 31%. Point made… when making investment decisions, it is very important that we invest in assets that we believe can do well given our outlook for the future not what has happened in the past.
- Fight knee-jerk reactions – it is human nature for us to want to DO something or try to FIX something when we feel discomfort or pain. This mentality can be applied to the current stock market environment. When we look at our investment portfolios and see a loss of capital, we likely want to fix the problem and the easiest way to do that is to sell the funds that are down – a knee-jerk reaction. These types of rash decisions can have a detrimental impact on the long-term success of your investment portfolio. To help fight this urge we recommend taking a step back and reviewing the investments that may be suffering losses in greater detail. For example, take a look at the longer-term trajectory for that particular investment. Do you think that the company or companies you own will be successful in their business over at least the next few years? If so, then maybe think twice about hitting the sell button.
- Stick to the plan – as we wrote about in our last newsletter, timing the market can cause investors to miss out on some of the best market performance days, which can lead to a drastically lower total return over time. When volatility hits, we certainly retest our thesis, but we also remain confident in the plan we set in place – whether that be to invest idle cash if the market draws down or to remain invested in the investment options we have confidence in. It is certainly OK to change your course from time to time, but sticking to the plan means we will not sell to cash when the market environment becomes challenging.
Investing in Down Markets
Despite that today’s market environment is “abnormally” unpredictable (especially on a day-to-day basis), it is possible that the volatility lasts for the foreseeable future. And while during times of market weakness and uncertainty, it is particularly important to ensure your portfolio is truly diversified, it is also true that there may be steps investors can take if they are concerned about the market falling further.
The first recommendation for most investors should be to fully understand whatever strategy that they are considering. For example:
- Shorting stocks: There are many new products and funds that allow individuals to “short” (i.e., bet against) the market and even leverage those types of bets. Unfortunately, these types of investments really are just another form of “timing” the market; if you are not right on when to place the short bet and when to take it off, you may end up doing more harm than good. “Shorting” markets should generally be left to trading experts.
- Tail-Risk Insurance: Buying certain “put” options and other types of insurance-like products. These can be effective, but also can be expensive, especially if the timing is not right.
- Low-volatility ETFs: These are good options and at NCM, we utilize certain types of funds/ETFs which focus on lower volatility equities and/or short-term bonds.
- Covered Calls: This is another strategy that we use to help in both generating current income while also offsetting potential losses.
And if one does feel the need to actively seek out specific assets or “counter-market” investments, here are some other examples:
- Commodities: These are specialized investments that target commodities such as gold, oil, wheat, etc.---those which may historically perform better in periods of slower growth and/or high inflation and/or weak markets. However, again, these investments can perform well in a temporary moment in time, but if not closely monitored, they can also negatively impact the portfolio over time if those particular assets to which they are dedicated fall out of favor.
- Managed Futures & Long/Short funds: These are both approaches that try to act as hedges against weak equity markets, and in some cases, provide some upside in bullish times as well. These are generally quite complicated and need to be considered carefully.
Overall, these are all portfolios strategies that can be used to help offset weak market conditions, but they should be implemented with great consideration; in truth, many are NOT great long-term investments and without being prudent in how they are used, these may prove to be more of a drag on returns rather than a positive. Many of these are very complicated strategies and in general most investors should approach them with caution. However, given the challenges in the markets, we do believe some of these strategies have been and will continue to be helpful to our clients.
In short, investors should consider this fact: According to a market note by Miller Value Partners, “markets have moved higher 73% of the years since 1927.” In other words, patience in investing is paramount, and it may not be necessary to take on new strategies during challenging times; markets have rewarded long-term investors, and it is often a well-balanced stock portfolio of quality names that will provide the best defense over time against weak markets. And for those with such a portfolio spread over asset classes—i.e., stocks, bonds, alternatives, etc., their holdings should typically not all move in tandem; that is, these portfolios by design should already hold investments that move higher when the overall stock market moves lower.
In closing, at NCM we understand the concern and unsettling emotions that the current market volatility can cause, but like all bear markets, we understand the best ways to help our clients navigate these times. We are certainly available to discuss any of these matters with you in greater detail.
Please feel free to contact any of us if you should have questions – thank you!
All the best,
NCM Capital Management
DISCLOSURE: This newsletter contains general information that may not apply to everyone. The information above should not be construed as personalized investment advice and should not be considered as a solicitation to buy or sell any security. Past performance is no guarantee for future results. There is no guarantee that the opinions expressed in this newsletter will occur.
Investment advisory services are offered through NCM Capital Management, LLC, an SEC-registered wealth advisory firm domiciled in New Jersey. This communication is not to be construed or interpreted as a solicitation or offer to sell investment advisory services to any residents of any state other than the State of New Jersey, the State of New York, the State of Texas, or where otherwise legally permitted. For additional information about NCM Capital Management, LLC, you may request a copy of our disclosure statement as set forth on Form ADV.