What’s Our Strategy?

In the past two trading days the S&P 500 is down 6.1%, nearly two-thirds the way toward what is widely regarded as a market correction – a 10% drop. Good news of job gains and pay raises have set investors’ eyes on what the Fed might do in the coming months to raise interest rates in order to stem inflationary fears, which may or may not be warranted.

Whether the ‘correction’ will be brief or longer-lasting rests both the potential of inflation (prices rising) becoming reality, and how the Fed reacts to the information it monitors. A too-heavy hand (increasing rates too aggressively) could derail economic growth, and too little action could result in inflation gaining a foothold in the American economy, making it economically and personally painful to root it out. Welcome to the Federal Reserve Chairman’s chair, Mr. Powell.

The fundamental question is whether the tax cuts will be invested by corporations into things and people that bolster real economic activity and growth; things that increase productivity and profitability, or whether the cuts will cause inflationary pressures that result in too much money chasing too few goods. It is going to take time for these uncertainties to resolve.

In the meantime stocks and bonds will likely pare their volatility and tread water for awhile. Bonds have been anticipating the possibility of inflation for weeks now. Stocks just joined the dirge, but in an historic fashion.

Speaking of historic fashion, let’s put the market’s recent move into some past perspective. We all know the stock market can be volatile, but many of us have probably been lulled into a false sense of security, given the near-decade-long run-up in prices steadily making new highs. Michael Batnick points out that the S&P 500 has traded within 3% of its all-time highs for an incredible 202 straight days. This period is almost twice as long as the second longest streak, which occurred from 1995 to 1996.

While we consider stocks to be a volatile asset, you might be surprised to learn how rare big moves like yesterday’s drop truly are. The chart below, taken from today’s Wall Street Journal, reveals that a significant majority of the time, 78%, daily market moves fall within 1% up or down. Moves like yesterday occur 0.3% of the time or just .8 days per year.

0218 Flash-1

It’s also important to understand the long-run trends when evaluating stocks and their merits. The overwhelming tendency of stock prices is up. This makes sense as we know that the prevailing tendency of company earnings, which drive stock prices, over time is up. Take a look at a powerful chart put together by our friend Ric Edelman of Edelman Financial Services. It reveals that stocks rise much longer and persistently than they fall, just as company earnings and economies do.

0218 Flash-2

A client asked me yesterday, ‘what was our strategy going to be in light of the market’s recent volatility?’ I reminded him that our strategy is built into our portfolios already, recognizing the two critical points made in the paragraphs above – the volatility of stocks can be unsettling but prices persistently rise over time far more than they decline.

Our portfolios are designed to deliver, as efficiently as possible, the persistent growth of the stock market (with maximum diversification) while mitigating the volatility of stocks through what we call our shock absorbers, or US Treasurys managed to the 7-10-year maturity range. Our Treasury holdings most often bounce when stocks are falling significantly, smoothing the overall volatility of the portfolio. Our Treasury position was up .87% yesterday. If you are interested in learning more about why we believe Treasurys are the very best hedge against stock market volatility, please read Case for Treasurys and Why do We Own Treasurys?

Back to my client’s question, what is our strategy? – our strategy differs for every single client in that we place them in no more risk than they confidently need to meet or exceed their goals. Only by understanding their important goals can we develop a meaningful strategy for capital market investing. Reacting to market whims is not a strategy.

Please give us a call if you feel it’s time to review and reaffirm your strategy.