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Strategies & Market Trends : Trader J's Inner Circle
SNOW 171.94+3.9%12:46 PM EDT

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From: Trader J4/24/2022 1:12:47 PM
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Market Thoughts: 4/24 - In the last week I've gotten quite a few private messages, emails, direct messages, calls, etc. regarding these markets, primarily from posters here on the Inner Circle, those I've worked with in the past in a 'wealth advisement role, and friends/family who know I'm in touch with the markets.

Before getting into my thoughts on some of the content and questions from these messages, let's take a look at where we stand in the markets related to the indexes and their 52WH (52 Week High).

Dow 33,811 -8.5%
S&P 4,272 -11.4%
Nasdaq 12,839 -20.8%

Most of the messages, comments and questions were one of the following:

1) So what are YOU doing in this market?
2) This is painful, I'm confused and I don't understand why it's happening
3) What can I expect going forward and/or should I sell?

Rest assured, I'm not singling out anyone here as I've had multiple questions within each of these categories.

Before going forward, let me reiterated a couple of key facts and variables that you should always have in the back of your mind.

1) Corrections (-10%) and bear (-20%) markets are a natural occurrence and should be expected. In the modern era since WWII, bear markets occur about once every 6 years or so. They typically last less than a year and the average market downturn amounts to about 36%. During the early days of the Covid crisis, the shortest (33 days) on record occurred and took the markets down about 34%.

2) While bear markets and recessions are linked, one does not guarantee the other. Many economic variables are at work during corrections and bear markets and, personally, I believe all are very unique and the existence one does not necessarily forecast the next based on similar variables ... though may suggest it.

3) Lastly, as part of normal market cycles, while painful, in every case the markets improve over time. This is why we use pragmatic strategies to diversify our portfolios, rebalance and, just as important, protect a level of cash and not commit it to the markets too quickly, especially in times of extreme turmoil. While there are many bad decisions you can make in the midst of a decline, one of the worst is to deploy all your cash too quickly such that you have nothing left to take advantage of lower prices later. If you are well diversified, you don't want to feel forced to sell positions to raise cash for purchasing other investments.

Let's answer some of the questions.

1) What are YOU doing now?

First and foremost, during extremely difficult days like we saw on Friday, 4/22, as long as I am able to, I do not pull up my accounts or check in on my positions. I'm always aware of my positions, portfolio structure and diversification, including cash, which usually affords me the opportunity to not have to look at my accounts. I'm not immune to the psychological impact of seeing large red days. It's only my discipline and my belief of what is to follow that helps me weather the storm.

You may ask: "But don't you miss out on opportunities if big down days?" - I may, but I'm also a big believer in not adding/taking positions unless I see true capitulation in the markets nor am I worried about trying to catch the absolute bottom in a stock. I'm far more interested in letting market dynamics play out and entering/adding new positions when I feel comfortable with a combination of position valuation and the market health. I'm comfortable with MANY valuations right now but not market healthy or the negative catalysts which remain.

On 4/19, I engaged in a large scale tax-loss harvest event to help match-off a large gain I had back in January. In this scenario, I looked at all my losing positions in my taxable portfolios and sold as many as I could to match-off my large gain with as much loss as I could generate. Note that I did not sell ALL losing positions. Most of the dollar amount was made up of bonds with about 20% made up from blue chip income positions I took earlier this year. My intent is to allow the wash sale period (30 days) to expire and retake many of the positions. That said, given current market variables, I expect my overall bond weighting will be materially less. Positions I did NOT sell were primarily financials (JPM, C, BAC). I'm too much of a believer in the long term trend of these names into the current environment.

Combined with this tax loss harvest, I now am sitting on a large amount of cash. While I wish my cash position was larger prior to the downturn, that was not realistic as I don't concern myself with timing such things, it's a fool's errand. Prior to the tax loss harvest, I was still sitting on a 'good' % of cash based on what I was seeing in the markets with a firm goal of not committing 100% of this cash too quickly. But remember that inflation eats at your cash as well, providing negative real returns. It's a balancing act.

At this point in time, I remain patient and committed to identifying value stocks that fit my investment thesis and profile and I'm nibbling when I can. For those of you who follow me, you know I like to take my positions in a stock with 3-5 small purchases over a long period of time to average out highs and lows. I routinely always save room for at least one more position based on extreme weakness caused by an unrelated market event.

With the Nasdaq in bear market territory, I have been nibbling at some of the big tech names such as GOOGL, AMZN, MSFT and even NFLX following the big decline. I have a long list of other names, both in value and speculation that I continue to watch daily. I'm more comfortable with nibbling in this space due to the declines already seen.

As far as the S&P/DOW indexes, I have far less conviction based on the declines seen thus far. I'll explain more in question #3 below. But basically, while I'm not afraid of an entry into pure value plays with real earnings, cash flow, PEG (P/E to Growth) and safe dividends, my purchases are measured, diversified, selective and small. There are a lot of well priced income and value plays available but remember the current market environment and our discipline.

2) This is painful, I'm confused and I don't understand why it's happening!

It most certainly is. I'm not immune to the feelings associated with down days and the specter of lost money. But my discipline and pragmatic approach is what keeps me balanced and yours should do the same for you. If it does not, it's a good indication that something is out of balance between your nature and your portfolio. Times like these do a fine job of highlighting when you may have too much risk, be out of balance or don't have an investment thesis which matches your risk tolerance/capacity.

Every fiber of my being felt this was coming a year ago, specifically in April of 2021. We began seeing the material building blocks of future inflation take hold. All the while the Fed was professing any inflation was likely to be "transitory." My wife and friends will attest to the rants I engaged in based on what I perceived to be "ludicrous" notions of the Fed. Anyone who knows me knows that I also nearly always give the benefit of the doubt to others as I understand many much smarter than I know what they're doing. I, and others in my circle, were certain "transitory" would end up being a huge mistake. Fast forward to only recently and inflation is now at 40-year highs, transitory has been stricken from current commentary and the Fed is so far behind the curve that its now trapped between NEEDING to raise in 50 or 75 bps moves to have any hope combatting current levels and upsetting the markets by doing so. In short, this is a Fed induced situation and they have created that which they were trying to avoid. In my estimation, the breakdown here was the Fed's willingness to be politically influenced at a very dangerous time economically.

The streets, once filled with dancing, now are seeing blood instead. Recessions and inflation don't necessarily walk hand in hand, but they are certainly very close friends and sometimes much more. We still have arguably the best job market ever, which could easily drive further inflation. Energy, core material, producer/consumer, staffing, etc. prices are all on the rise. The Fed is doing their best to prepare the markets for what they know the now need to do and the chance of a soft-landing, a term now getting a lot of play again, is very small. The Fed rarely executes a soft landing. Threading the needle this time projects to be nearly impossible and the risk of over-shooting rate adjustments over the longer term is great. But to not be aggressive with rates means further risk of inflation run away.

Some very smart people are saying the Fed Funds rate will need to be MUCH higher than the projected 2023 rate of 2.75%. I don't think it's out of the question that we could see that rate by the end of 2022 alone. Some experts have projected, based on historical models, that the rate will need to be in the 6-8% range if we hope to fight this window of inflation. To wit, we are seeing inflation at 40 year highs. In 1981, the Fed Funds rate was 16%. Let that sink in.

3) What can I expect going forward and/or should I sell?

If you've stayed with me this long into this missive, you may already know where I'm going. The picture I'm painting isn't one of near-term strength though I don't discount the possibility of it.

As such, I have not sold any of my core position outside of the tax loss harvest execution. I executed the tax loss harvest at a time where I felt that between current market forces and the earning season, I could capture the loss, wait 30 days and then determine what I wanted to do going forward. As I seek to derive income and relative safety with my taxable portfolios, my desire is to have this money in income producing vehicles while having just enough cash on the side to take advantage of further market declines. In my non-taxable accounts, where I prioritize growth, I'm cherry-picking growth names to own for the next 10-20 years in weightings that allow me to stay balanced. I am NOT committing my cash aggressively as I don't know what the near term holds.

Here's the crux of the matter. The number of messages I've been receiving picked up materially over the past two weeks. Psychology plays a role in the markets. We are not immune to it and we are part of that collective. With the Nasdaq now in bear market territory, you'd think perhaps the water may be safe. The bigger issue is that we have the S&P down 11.4% from highs. Recall that the average bear market decline is closer to 36%. The names making up the Dow and S&P, large cap stocks, have been buoying the markets to some degree. With rotation out of tech/speculation and into value and income, the declines in those indexes have been muted.

I cannot discount the fact that the market forces at work could now begin eroding the confidence in those very same value/income names which have held up so well to date. There are a large number of names that are between tech/speck and value/income which will likely unwind first should this occur, but few names will be spared IF we descend into bear market territory with all major indices.

Anxiety is high in the markets and we only have the S&P down roughly 1/3 of that to the average bear market. A lot of pain exists as a potential considering the fact we are still on the front end of the Fed action (rate raises) and the impact of the costs associated with that scenario, meaning the economic decline to fight inflation. This is the recipe for recession. So while the current market decline has been material, it arguably has yet to price in expectation for recession or material economic decline from here.

All that said, my M.O. remains to be a long term investor and take advantage of value where I can find those opportunities. I see some in tech (GOOGL, AMZN, etc.), I see some in banks (JPM, C, BAC, GS, etc.), I see some in value/income (PG, KMB, GIS, VZ, ABBV, etc.) and I see many others across sectors (HD, BRK/B, CSCO, DKS, QCOM, NWL, etc) which should perform well going forward and see less decline into greater turmoil. I'm even seeing opportunity in my favorite non/low profitability tech stocks names which are my favorite for the long term including NVDA, SNOW, TWLO, ETSY, PYPL/SQ, DKNG, RBLX, RIVN, etc. But I will not rush into any of those last names as low/no income names will continue to be punished in this market cycle.

I'm protecting my cash, only taking entries for which I have conviction for and bracing myself for further down days in 2022 as we fight the current economic climate. But, my long term investing thesis remains and yours should to. Check your weightings and diversification, your risk-profile vs. your risk-weighting and ensure that you are sleeping at night, the best indication I've found that my investments are in balance with my comfort level.

I expect I will have an elevated level of cash into the foreseeable future which I will use over the next 24 mos. to take my conviction positions. I am decreasing my bond allocations for the near-term due to the rising rate environment. Many bonds are already down 10% so I'm late to the game on that front, they also provide needed shock absorbers in normal times.

I hope that gives you greater perspective on what I'm doing now and my thoughts on these markets. As always, you can reach me here for questions or comments and if you send me a private message, I can give you my InnerCircle email address for more direct communication.

Stay well and be good to each other!

TJ

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