Is the Stock Party Over?
Forty percent (40%) of company stocks listed on the NASDAQ are down by 50% or more,¹ market breadth in the NASDAQ, Russell Micro Cap Index, and all Asia Indexes are negative and falling,² and credible and accomplished investors are starting to warn of an impending bear market. What factors suggest the stock party may not end just yet, what are the risks to this outlook, and what are prudent investors doing right now to protect both their returns and capital?
The stock market is one of the greatest wealth building tools in the world, but it is also ruthlessly counter-intuitive, inflicting the maximum amount of pain possible on the maximum number of investors. The following issues suggest the stock market may overcome rising headwinds for now:
Stocks have not historically peaked at the beginning of a Fed tightening schedule, and rates have not even begun to rise yet; but stay alert, for the Fed has never been smart enough to avoid raising rates too far in an inflation-fighting series of hikes.
Long bull markets generally end in euphoria with potential investors “all in”, but today market pessimism remains, particularly with institutional money managers and wealthy individual investors. History suggests both will go all in before the music stops.
Policy, as of now, remains wildly favorable towards owning stocks, and wildly unfavorable towards owning fixed income investments; in fact, though the Fed speaks, nothing in this equation has changed as of yet.
Since 2008, every time stocks throw a tantrum the Fed quickly decides re-inflating the stock bubble is top priority. Now that the solvency of the U.S. government is a global question, the Fed is highly reluctant to raise rates much, and equally likely to accept a higher rate of inflation. Jerome Powell is not Paul Volcker!
Major bear markets have always been accompanied by economic recessions, and right now the U.S. economy is growing.
Recessions are preceded by an inverted yield curve, and save the 20Year and 30Year Treasury Bonds, this has yet to occur.
Risks to this outlook are numerous. The Fed may be behind the inflation curve, which means rate hikes may be accompanied by still rising inflation, a worst case scenario for stocks. The Fed is now panicking, a recipe for policy error. Threat of war with China is rising. The pandemic isn’t over, nor the possibility of additional lockdowns. Any of these could swiftly terminate the ongoing bull market in stocks.
The following actions should prove helpful in successfully navigating today’s dangerous investing landscape:
Stay well diversified, and obey the position sizing rule of 3%-5% for individual stocks.
Maintain a well-defined “exit plan” on all non-forever stock holdings, and stick to it.
Avoid over concentration by maintaining a well-diversified portfolio.
Build a strong cash position to weather the potential storm, and to have investable cash when great companies are dirt cheap.
Focus on high quality companies with present streams of income.
Own a chaos hedge or two.
Happy New Year! Please think about it, Shaun.
“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”
~Warren Buffet
“Give a portion to seven, and even eight, for you know not what disaster may happen on earth.” ~Ecclesiastes 11:2
1 Bloomberg.com, “Number of NASDAQ Stocks Down 50% or More Almost at a Record”, January 6, 2022
2 MarketInOut Stock Screener, January 7, 2022
https://www.marketinout.com/chart/market.php?breadth=advance-decline-line
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial. The economic forecasts set forth in this commentary may not develop as predicted.
All investing involves risk including the possible loss of principle. No strategy insures success or protects against loss.
Asset allocation does not ensure a profit or protect against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.
All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.