The stock markets are officially in or approaching bear market territory but it’s much worse than that beneath the surface. The Bull market since 2009 appears to be over.
Take for example the bull market darling index, the Nasdaq 100 (QQQ) which is now down -21% year to date but the median stock in the index is down a whopping -40%! The worst start to the year for the Nasdaq 100 ever. Add to that almost a quarter of the index is down by -75%.
The S&P 500 index (SPY) has fared better, sort of, and is down -14% but a full 70% of the stocks in the index are under their 200-day moving averages! This is the worst start for the S&P 500 since 1939.
The economically more sensitive Small Cap Index (IWM) is down -22% on the year and topped out in March of last year.
Bear market statistics indeed.
Back In February, with indexes still close to all-time highs, I commented to the J2 staff that it might be one of the top 3 worst markets I have seen, and no one realizes it. I fully understood the absurdity in the statement given we were near all-time highs, and I have seen some crazy bear markets in my time, but things were not well with many sectors and stocks. The damage was being masked by just a few large stocks keeping the indexes afloat. The quiet stock market crash has been going on behind the scenes for over a year and keeps moving from one sector to the next like a wildfire.
J2 starts to move to defense in February.
Our internal indicators were flashing a possible bear market and recession signal as early as February of this year. J2 started to raise cash slowly and almost every week across strategies. We had many signs that gave us some confidence that the next few months may not be kind to those that stayed at the party too long. I will expand on this more later.
By late March, J2 Capital was in full bear market positioning across all strategies. Each of our strategies is managed differently for bear markets, but the emphasis is placed on reducing volatility for our clients. These early moves helped to limit the damage in all our strategies.
Our goal is to not avoid all losses, as this requires knowing you will be right without a shadow of a doubt. Investing is never this easy or precise and I tend to use my experience of 25 years and our internal models to help guide me.
There are times when capital appreciation makes sense and other times when limiting possible damage is more important. We are in one of those times when protecting you by limiting the potential damage makes more sense by heading to the sidelines for a while.
Steps we are taking:
We have been slowly selling equities for months. Most strategies are heavily in cash. Bonds have not been a safe haven. Many advisors who are using a traditional 60/40 allocation are deeply red on the year as both stocks and bonds have been clobbered. We warned that this was going to happen to the 60/40 portfolio back in November of 2021. Will the 60/40 Portfolio Put Your Retirement at Risk?
We will keep a modest but small allocation to equities and equity ETFs.
We will not time the bottom but wait for a better investment climate to get money back into the market. While we will look for longer-term opportunities to buy into we will not try to time the bottom. As we have seen, any rally has been short-lived as the strategy moves from buy-the-dip to sell-the-rip. This is not a market we want to participate in at present moment.
Currently, our ETF strategies like our Low-Volatility strategies are holding cash levels that haven’t been this high since March 2020 and 2008. Our equity allocations are around 1/3rd of what would be normal. The volatility of these strategies has been reduced so significantly that we are capturing around just 20-30% of the stock market’s daily moves. These are tolerable fluctuations for most.
Our stock strategies Dynamic Mid-Cap Growth & Value and Dividend are also holding large cash allocations of around 30%, along with a small inverse market ETF and a volatility hedge. Our stock strategies appear to be capturing around 50-60% of daily market moves, in line with our objectives for these.
Our goal in a bear market is to help you avoid the devastating losses that can occur during these times that may impact your future. Recovering from a modest loss is easier than a 20-30% drawdown.
Most of our clients are either pre-retired or retired and bear markets can adversely affect future dreams.
Younger clients and those with long time horizons may be best served by remaining fully invested and buying more through their 401k plans and such.
In summary, this is not a healthy market environment at present. We expect, continued large price swings in both directions. I am expecting a large rally to occur shortly, maybe timed to the Fed this week. We will need to see what happens after the large relief rally takes place. It’s possible that we could remain in a large sideways pattern for a while, or a new lower low will happen. We may be witnessing the end of the great bull market of 2009-2022 and a new bear market has taken over, the 4th bear market of my career. That’s too many in one career.
We will be cautious in trying to catch the proverbial falling knife as the buy-the-dip mentality of the past decade looks to be over for now. This is not to say that we won’t selectively try to add to quality names and index ETFs, but we also much prefer to wait until our indicators signal, that we are back in a healthy market. That may mean giving up some initial upside, but it also means I am not trying to guess if the bear market is over.
We always welcome client feedback, and should you feel the need to be more aggressive we encourage you to reach out and have a discussion.
What’s driving current conditions
In short, the Fed liquidity that the market has been living off for over a decade is in reverse now. Jerome Powell and the Federal Reserve placed a bet in mid-2021 that the surging inflation we were seeing, was in their words, “transitory”. The Fed believed that it would dissipate on its own. This big bet has turned out to be incorrect. We had too much demand chasing too few goods, the classic definition of the cause for inflation. Never mind for a moment, that both the surging demand and the “too few goods” were both created by our Federal Reserve and politician’s during Covid. The Fed is now woefully behind the curve in fighting inflation. That’s even before we discuss the Russia-Ukraine war and how that’s impacting commodities like Oil and Agricultural goods. The Federal Reserve will attempt to engineer a soft landing while reigning in inflation. No easy feat.
Worst of both worlds
What could be worse than runway inflation and war in Europe creating chaos in energy and food markets? How about a slowing U.S. economy teetering towards recession? While many are still touting and believe in a continued Covid recovery we were tracking economic numbers back in February that seemed off with the narrative of a surging consumer. Sure, pockets of the economy looked great like big-ticket items in housing and autos, but retail sales were coming in below expectations as early as January. Something seemed off.
Then the shocker came this past week when U.S. GDP for the quarter fell at -1.4% missing expectations big. We are now just one more negative quarterly GDP print in July away from an official recession call.
We now have for the first time ever a Fed that will be hiking rates and stopping quantitative easing into a negative GDP print and a slowing consumer. Truly, the worst of both worlds.
The housing market, one of the bright spots of the economy during Covid has now likely come to a standstill in many parts of the country due to rising interest rates. To put the sky-rocketing interest rate rise in perspective, consumers just back in January were locking in 3% 30-year rates. In just a few short months, 30-year rates are now over 5%.
The stock market telegraphed this, but everyone ignored it.
Going to a party is a lot of fun, but sometimes staying too long can lead to bad decisions. As with all other bull markets of the past, investors may have stayed at the punch bowl way too long. In retrospect, the market was giving clues that it could be in trouble for over a year, but it went largely unnoticed.
We can trace the beginning of the market peak back to February 2021. This was the month that the ARK Innovation ETF (Figure 1-ARKK) which will end up becoming the poster child for excess Fed liquidity and investor exuberance run amok, peaked. Combine a catchy slogan (disruptive technology), add in some young analysts who only have seen a bull market, then juice it with a marketing campaign and stratospheric stock price targets (i.e. Tesla to $4,600 a share), and you end up with a portfolio of speculative money-losing technology companies with others over-valued beyond anything we have seen. Sounds a lot like the Tech bubble of 1999, doesn’t it?
Of course, many were hiding out in the perceived safe bellwether stocks of the big tech giants. These giants control most of the index performance. We know one advisor that placed all his clients in just 5 of these stocks as the core of client portfolios. These tech titans have become the most over-owned stocks we have seen since the Nifty Fifty stocks of the 1950’s. One by one we have lost all the fabled FAANG stocks. Apple at present looks like the last one truly standing. However, many are still clinging to the notion that Apple cannot go down and can buck the trend. This might be the last bull market narrative left to test and I have a feeling this one will not end well either.
Here are the Year-to-Date performance figures for what are the considered the best Tech companies in the world:
- Facebook -40%
- Apple -13%
- Amazon -25%
- Netflix -70%
- Microsoft -17%
- Tesla -17%
- Google -21%
One by one, sectors and stocks are getting taken out. It almost appears to me that it’s possible the market and most stocks will give back the entirety of their Covid gains to February 2020 levels. That would be amazingly bad should that happen. Possibly the market recognizes that the massive bull market coming out of Covid was all juiced by a massive money supply, zero percent interest rates, and massive fiscal stimulus. Was it real organic growth or simply a one-time occurrence? Now add in a Fed that currently isn’t there to save the markets and things can get pretty wild fast.
The Bullish Scenario
To keep things balanced there is a bullish scenario that is making its way through the financial media. Those bullish on the market believe that inflation may have already peaked. I don’t see much evidence for this yet, but this would be an important first step if the market is to the bottom.
Falling inflation would allow the Fed to slow down or even pause its rate hikes. The thinking here is this would allow some of that liquidity to stay in the market while the inflation and interest rates come in. I find this scenario hard to comprehend since a bullish stock market likely would return a consumer back to bidding up big-ticket items once again and thus an inflation resurgence due to still broken supply chains. Until the global supply chains get fixed, and inflation falls, the Fed is in a tough spot. It is worth noting that China currently is adding to supply chain chaos by locking down many cities due to Covid. The Fed can reign in demand but are powerless on the supply side.
The next few months will be very volatile for both the stock market and the economies of the world. We will continue to play it conservative and wait for signs of stabilization.
If you have any concerns or questions about your accounts, please reach out to me.
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About John Benedict
John Benedict is CEO, investment advisor representative, and portfolio manager at J2 Capital Management, a boutique financial advisory firm specializing in in-house custom financial planning, tax, estate, and investment management. With over 20 years of experience, John is passionate about helping clients navigate uncertain markets, reduce risk, and plan for a sound future. John combined his talents and passion in statistics and technical analysis to create J2’s tactical strategies, managing them since the beginning of the organization. He is known for being a visionary and continually looking for ways to improve J2’s services and strategies to better serve his clients. John graduated from Central Michigan University with a degree in business administration and finance, and his thoughts on markets and technical analysis have appeared in The Wall Street Journal, Investment News, and Moneyshow.com. He was also a contributor to the book The StockTwits Edge: 40 Actionable Trade Set-Ups from Real Market Pros.
When he’s not working, you can find John boating or participating in water sports and spending time with his wife, Janine, and his three children, Jack, Alexis, and Saraphina. To learn more about John, connect with him on LinkedIn. You can also register for his latest webinar on What Makes J2 Capital Management Different From Other Financial Advisors.