“The only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance.” Franklin D. Roosevelt Inaugural Address – March 4, 1933
At present, the NASDAQ is in a bear market, down 22.7% from the last fall’s record level while the S&P 500 is in a correction, down 13.1% from the January record.
U.S. stocks started the year on a downbeat and hit a low for the year on March 14. Within a few days, stocks recovered to down just 3.5% YTD. In April, however, economic and political news went from bad to worse. As of April 29, U.S. stocks are just a hair above the low the year, with the S&P 500 falling 9.1% in April.
There’s an odd disconnect between U.S. stock market performance (bearish) with U.S. economic performance (best in years).
- 7.9 million jobs added since January 2021
- U.S. unemployment rate is just a 0.1% above the post war low of 3.5%
- Real wage growth rebounded sharply last year after a decade of little to no growth
- Consumer demand remains high, particularly around housing
- Corporate revenues and earnings are solid
Why are investors so frightened?
- Ukraine war looks set for a decade of slow motion slaughter
- Pandemic is still not over
- Energy prices quadrupled since the March 2020 low, though still 25% below the June 2008 record
- Real food prices are at the highest level since the inflationary 1970s
- Interest rates are headed higher, though the current Fed Funds target of 0.25% is a long way from the 2.5% rate of April 2019 or the 5.25% rate that prevailed from 2006-07.
- Mortgage lenders aren’t waiting for the Fed – the 30-year fixed mortgage rate jumped from 2.65% in January 2021 to the present 5.1%
- The level of national discourse has descended to total idiocy
Investing brings on an intense mishmash of emotion. When markets rise, so do spirits; when markets fall, panic ensues. Fearful investors sell during panics, hoping to buy back “when things are better.” Unfortunately, this approach is a commitment to “sell low and buy high.”
At present our firm is INCREASING our exposure to equities for clients. Yes, reading the daily headlines is not fun, but we have RULES to remove emotion from our investing. Here are a few rules that any investor can implement:
Rule #1: Avoid over-concentration in a single stock or sector
The 2021 meme stock frenzy showed us an extreme example of the perils of over-concentration.
People dumped all their savings into single positions in long shots like GameStop and AMC, then presumably wept and/or panicked when the stocks came crashing back to Earth.
We see less extreme examples of over concentration when people put all their retirement savings in company stock, or when people own large positions in popular companies.
For the last several years, the FAANG stocks (Facebook, Amazon, Apple, Netflix and Google) were a one-way trade to success. In the last four months, Facebook declined 48%, Amazon 34%, and Netflix 73%.
We own Amazon, Apple and Google, but we have been net sellers of these companies over the last decade, trying to keep our average position to 2-2.5%, and try to keep our overall sector exposure (e.g. healthcare, technology, energy at 15% or less). For sure we do not sell positions at the top tick, but neither are we harmed by the current downdraft in, for example, large cap tech stocks.
When you put too much money in one company — or one sector, or one industry — you imperil your future. Think of the GE-lifers who invested all their retirement savings in GE stock, only to see it plummet, flail, and plummet again, declining 84% from the all-time peak in October 2000.
Rule #2: Budget for capital gains taxes
When we scale out of a profitable position to avoid concentration risk, the sale triggers a capital gains tax. Clients HATE paying capital gains taxes – the profits in their portfolios are intangible, but money going out of their checking account feels real.
In conversations with our clients, we establish an annual budget for paying capital gains. A client might be comfortable paying $100K, but upset paying $250K. We communicate the budget to the clients’ accountants, who will then prepare vouchers for estimated taxes. As the year progresses, we take gains up to the budget, and later in the year look for offsetting tax losses, if available.
We send quarterly updates to clients and accountants to adjust withholding as the year progresses. The process is not perfect, but the point is to avoid feeling ambushed when April 15 rolls around.
Rule #3: Concentrating on the most recent news while ignoring the larger picture
We describe our investment process as the “mosaic approach.” A handful of tiles scattered on a work bench have no value, but 30,000 tiles arranged on a wall create a work of art. Our portfolio team is tracking hundreds if not thousands of data points, looking backwards as well as forward; out of all this data comes a vision of what’s really going on.
We can think of 50 bits of news over the last 25 years that caused stocks to fall 5, 10, 20% with the largest declines associated with the COVID outbreak (down 35%) and the 2008-09 financial crisis (down 55%).
Whenever the stock market offers us good companies at discount, we are willing buyers. Why do we have this confidence? Nobody at JP Morgan, Pfizer, McDonalds, Google or tens of thousands of other companies both public and private stops doing their job because there’s bad news. Headlines control short term market moves of the next day, week, even month. In the longer term (1-5 years), the stock market only cares about revenues, earnings and interest rates.
Our forecast today is pretty much the same as our forecast at the start of the year: rising revenues and earnings will push stock prices higher, while higher interest rates will push prices lower, for net gains in the S&P 500 of 6-9% by year end. A year end gain of 6% would be 22% higher than where stocks closed on Friday.
David Edwards is president and wealth advisor with Heron Wealth, a $500 million registered investment advisor based in New York City working with 225 client families across the U.S. and around the world. Dustin Lowman contributed additional research for this column.
At time of publication, Edwards and/or his clients held positions JP Morgan, Pfizer, McDonalds, Google, Amazon, Apple and Google.