I hope you and your family had a wonderful Labor Day Weekend!
Apparently, the long weekend was not enough time for people to change their mind, jump in, and buy stocks. The market closed lower yet again. For the Nasdaq, that makes seven trading days in a row with a lower close. The rally we saw off the June bottoms has faded quickly, and it seems that the bear market that began 2022 is overstaying its welcome.
This is not a surprise. We at Zynergy have been concerned about valuations and economic conditions since mid-2021. We continue to remain concerned, telling our members at mid-year reviews that we expect it will get worse before it gets better. In fact, we did a significant rebalance in early August to move our portfolio’s firmwide to a more conservative bias, even more so than we had in place already, having been defensive since late 2021.
An Inevitable Market Decline
We discussed our thoughts on this in detail in our Year End Review introduction letter. The single greatest driving factor in our opinion to lean conservative was due to equity valuations. Stocks have been and remain overvalued. In addition, the pervasive mentality of speculation and risk taking that we observed in 2021 was reminiscent of tech stocks in the late 1990’s and real estate in the mid- 2000’s. Either one of these can be deadly to the market an economy, but both combined is certain to lead to pain.
This is what we are now experiencing, the hangover of the liquidity fueled party that the economy and market experienced in late 2020 and 2021. The flooding of cash into our economic system through both fiscal and monetary means in the last two and a half years has created tremendous supply and demand imbalances that will need to be reckoned with. Here we are, 2022 and the day of reckoning has arrived.
Unfortunately, the unwinding of these imbalances will take time and pain. Stock valuations are high but falling. However, if our economy begins to slow, which it almost certainly will if we are to stifle inflation, then earnings will also fall, making stocks seem even more expensive. The underlying theme is that the market decline we are experiencing was inevitable and is probably not yet over.
Should I Cash Out?
The question that may be coming to the tip of your tongue as you read this is, “If the market is going to continue to fall, why don’t we go to cash, sit on the sidelines, and wait this out?”
Although an understandable question and on the surface, a sound strategy, taking an all or nothing approach in a bull or bear market is almost never advisable. There are several reasons for this:
- Timing: The problem with an all of nothing approach is you need to be right twice. Not only will you need to sell everything before a significant drop but have the foresight to get back in before what will almost certainly be a neck breaking rally off the bottom. Think about it, if you are uncomfortable with stocks now, will you be more comfortable when they have fallen another 15%, continue to make new lows, a recession is confirmed, and there is panicky talk on every news network. These are the signs of market bottoms. I think we all accept that buying back in during these conditions is not likely if we are honest with ourselves.
- Income: Our current investments, despite their conservative biased, will continue to shoot off income in the form of dividends and interest. In some cases, significantly so as the Inflation Protected Securities (SCHP) are yielding approximately 7.5%. This income will be imperative to allow us to reinvest as the market falls or pay out in the form of monthly distributions to our retirees. Holding funds in a cash or money market account will pay almost nothing and strain the principal of the account if distributions are required.
- Humility: What if we are wrong? As most of you know, the weatherman could not accurately predict the weather on Labor Day in the Tri-State area only 24 hours before. Humans are notoriously bad at predicting the future. Despite our warnings and concerns about the economy and stock market over the next 6-9 months, we cannot be sure that it will go lower. Our crystal ball is and will remain cloudy.
The game of all in or all out almost always leads to major errors that cannot be recovered from. This is not a game anyone should be playing with their life savings. Our philosophy is based on the premise that over time, your portfolio will do well. We will get roughly the returns we anticipated in your financial plan as the market highs and lows work themselves through over multiple years. Our objective is to achieve those returns while reducing volatility. Holding a conservative portfolio when stocks are expensive and an aggressive portfolio when stocks are cheap is the best way I know to perform well over time while we reduce the swings. However, staying invested remains the most crucial component.
Riding Out Short-Term Swings
If you are retired, your monthly distribution will remain unchanged regardless of the daily market volatility. If you are about to retire, your ability to do so will remain unaffected by short-term market swings. Lastly, if you are saving towards future retirement, bear markets are great opportunities to purchase more shares at cheaper prices. It is the accumulation of shares that matter most when you are building a portfolio, not the short-term performance. With the right diversification in place, the results will take care of themselves.
You can expect that things will get worse before they get better, and we are prepared. Spend your time on the things that will make your life productive and enjoyable. Family, work, hobbies, and fun are all a better use of your time than watching CNBC or reading the Wall Street Journal in the middle of a market selloff.