By John Benedict
We’d all hoped that things would have calmed down by now, but the volatility of the 2020s just won’t quit. From a global pandemic and historic inflation to an unparalleled housing market and a war in Ukraine, it’s hard to believe we’re only two years into this decade. The economic uncertainty of the last few months has many anxious to know where we’re headed. Let’s first reflect on what we have been doing and saying this year.
In February, J2 Capital Management noticed weakening technical signs in the stock markets as many stocks were cratering, especially in high-growth technology, with only a handful of larger companies keeping the major indexes afloat. This dichotomy hid the damage under the surface and was a warning sign to us. We started to take down risk in client portfolios by selling high-growth stocks that were overvalued and raising cash.
In late April, we sent out a market update asking, is the 13-year bull market over?
In this update we warned that the potential for a large market drop and a potential recession was on the table—well before anyone in the media discussed it. Three months later, the bear market has arrived, and almost everyone knows about the recession. If you sidestepped most of the drop this year, great, but the easy part is now over. Bear markets usually occur in phases absent any Federal Reserve easing or bail-out intervention. According to Investopedia, a bear market has four phases.
- The first phase is characterized by high prices and high investor sentiment. Toward the end of this phase, investors begin to drop out of the markets and take in profits.
- In the second phase, stock prices begin to fall sharply, trading activity and corporate profits begin to drop, and economic indicators (which may have once been positive) start to become below average. Some investors begin to panic as sentiment starts to fall. This is referred to as capitulation.
- The third phase shows speculators start to enter the market, consequently raising some prices and trading volume.
- In the fourth and last phase, stock prices continue to drop, but slowly. As low prices and good news starts to attract investors again, bear markets start to lead to bull markets.
If we look at these four phases, the market likely has completed #1 and could be completing #2. We may be entering the third phase, or the “eye of the storm” phase. Typically, this is where it will get more complicated for everyone as investors hope that all the bad news is likely priced in and higher prices from here will happen.
Understand that bear markets exist to take money from everyone as large rallies occur followed by deep drops and continued volatility likely will confound many over the next 3-9 months. Should you get too negative, the market will make you pay by turning in large weekly or monthly rallies that will have you kicking yourself for selling at the bottom when people panic the most. We are experiencing that large rally now, just as many sold a couple of weeks ago, and short interest in the market was at a multi-year high. As the markets rally, many will be unable to resist the temptation of buying back over the next few weeks, believing the worst is behind us, only to see markets likely fall again.
We believe things will take a lot of time to work themselves out, and nothing will be linear or go up or down in a straight line from here. No one knows what path the economy or markets will take over the next year. Yesterday GDP printed its second consecutive negative quarter marking a “technical recession” for the economy. The problem is no one knows what kind of recession we will have from here. Will it be short and shallow, or a long and a deep recession? What about inflation? We can see that inflation is coming down due in part to the Federal Reserve tightening financial conditions, producing the recession we now find ourselves in. Even though inflation is coming down, we don’t know where it will settle. Inflation dropping is a positive for the market, but not if the new level is still higher than the long-run average or above the Fed’s target of 2%.
The market finds itself in a box or catch-22. Should it rally too much from here, it could also reignite inflation, as the wealth effect takes over again, causing too much money chasing too few goods in a supply chain that still needs time to repair itself. A sustained market rally likely could see the Federal Reserve having to tighten conditions even more than markets are predicting, probably producing an even steeper economic decline.
What Should You Do?
We talk with many individuals who are not J2 Capital clients or who are with other advisors. We have noticed that many did not or forgot to rebalance their accounts during the 13-year bull market. Many have come into 2022 with too-high stock allocations given their age and goals. Here I am talking about those pre-retired or retired individuals. We have also noticed that many of these portfolios have too much allocated to the high-flying growth stocks that led the market the past 5 years. This is very reminiscent of what happened to investor portfolios during the 1999-2000 technology bubble.
Our advice for many is to review your financial plan and goals and determine if you are over-allocated to equities and stocks. Next, determine the appropriate mix of stocks, bonds, and cash. Cash is finally paying rates above 1% for the first time in a decade.
The market is currently in the middle of a good-sized bear market rally. While we don’t know if the bottom is in or another selloff is coming, the time to right-size your equity allocation may be on us as you recover some of your losses. You may also want to review your allocations to the former high-flying technology companies and begin to balance these against dividend and more high-quality stocks and bonds.
J2 Capital Management currently has high allocations to cash and other short-term safe assets while holding more high-quality stocks and U.S.-based indexes in our strategies. Our market indicator still shows we are in a high-risk market where market volatility may continue. Our method is to wait until our market indicator has signaled the market environment is healthy and conducive for longer-term investing. That time is not yet here. However, since we were able to sidestep some of the market losses, we will still look to selectively add to higher-quality stocks and other indexes where we feel we can get a margin of safety. We have done this over the past few months in our stock-based strategies.
Here is an example of us selectively putting cash to work on market drops.
J2 Dynamic Mid-Cap Growth:
- (ODFL) Old Dominion Freight Lines: Among the top LTL truck carriers in the U.S., it’s an extremely well-run company that has exceptional management.
- (ALGN) Align Technologies. The maker of Invisalign braces, the company owns a monopoly in the industry and is used by almost every orthodontist. We bought the stock after a 60% drop.
- (HLI) Houlihan-Lokey. HLI is a company focused on restructuring deals and mergers and acquisitions. HLI will have plenty of business and likely will become a beneficiary of the current recession.
J2 Dynamic Value & Dividend:
We are more conservative with our selections here and have opted for historically more recession-proof businesses that offer higher dividends while we ride out the market volatility.
- (PG) Procter and Gamble. The consumer products company, and maker of everything from diapers to soap, razors, and anything else you buy, pays a 2.5% dividend and offers a margin of safety in a recessionary environment.
- (SBUX) Starbucks. We purchased this well-known coffee retailer at 40% off its old-time high. Starbucks pays a dividend of 2.3% and recently brought back their old CEO and founder Howard Schultz.
J2 Low-Volatility ETF strategies:
In our more conservative ETF strategy, we have been happy with remaining diversified with primarily U.S.-based indexes, short-term bonds, and high cash levels. Our most conservative clients need these strategies, and we are prone to react more slowly, getting back fully invested when our long-term indicator suggests a more healthy market.
J2 Capital is here to help you review your current portfolio to ensure it aligns appropriately with your goals and objectives. We have helped many restructure their portfolios during this bear market and offer unique and sophisticated ways to manage your current investments. Our highly customized investment approach may be just what you need.
Moving on from what you and we should do, let’s take some time to reflect and review what’s happened so far in 2022.
Stock Market Performance
It’s no secret that the stock market has seen increased volatility in the last couple of months—partly due to geopolitical events and partly due to the continued effects of historically high levels of inflation (8.6% for the 12 months ended May 2022). (1)
With the S&P 500 now officially in a bear market, defined as a 20% decline from a recent peak, (2) experts and some of the country’s top CEOs like Elon Musk and JPMorgan Chase CEO Jamie Dimon are warning that a recession is coming. (3)
This year has seen concerns regarding the global economy reach new highs as many countries struggle in different ways:
- The ongoing COVID-19 surge in China has prompted fresh rounds of lockdowns and stifled economic growth. (4)
- The ongoing war in Ukraine and subsequent sanctions against Russia have intensified supply-chain disruptions and increased prices in the energy, food, and commodity industries. (5)
- High inflation in the U.S. is reducing demand for everyday goods and could send the economy into a recession. (6)
There’s no way to know exactly how all these events will unfold, but our best advice is to keep calm throughout the storm. Stock market volatility, and even recessions, are normal parts of the economic cycle, and sticking with a tried-and-true investment strategy is the best way to navigate uncertain times.
Employment levels have steadily been returning to pre-pandemic numbers, with the June 2022 unemployment rate remaining at 3.6%, unchanged from April and May. (7) This number, about 6 million people, is similar to the February 2020 pre-pandemic rate of 3.5%, or 5.7 million people. (8)
The payroll employment sector also saw an increase of 372,000 jobs in June, which was over 100,000 jobs higher than expected estimates. (9) Education and health services were the leading industries for job creation, followed by professional and business services, then leisure and hospitality. (10) The continued growth in the payroll employment sector defies what many experts would expect from an economy headed for recession. (11)
Interest Rates and the Federal Reserve
In response to surging inflation, the Federal Reserve yet again raised interest rates on June 15th by 0.75%, the largest hike in a single meeting since 1994. (12) As alarming as this already is, further raises are expected, up to approximately 3.4% by year’s end. This suggests another 1.75% in total rate hikes, spread across the remaining four scheduled policy-setting meetings this year, a much steeper path of rate hikes than was predicted in March.
There is much debate over how much rates should rise in order to effectively combat inflation. Too much of a rise could halt economic recovery, whereas too little could keep inflation rampant and send the economy into a recession. However, a Fed statement reiterated its resolve to ongoing increases, with Fed Governor Christopher Waller stating he is “definitely in support of doing another 75 basis point hike in July [and] probably 50 in September.” (13)
What Does This Mean for You?
The unknown can be scary. In fact, billionaire and founder of Patagonia, Yvon Chouinard, has said, “Fear of the unknown is the greatest fear of all.” But rest assured, we at J2 Capital Management are watching over your portfolios and making necessary adjustments if and when markets dictate.
If you don’t have a financial partner to help you weather these uncertain times (and whatever lies ahead), we offer experienced and objective advice while putting our clients’ best interests first at all times. We can come alongside you as we navigate your financial challenges and opportunities with confidence. To learn more about our 2022 outlook and how we can help you, schedule a meeting online or reach out to us at email@example.com or 248-641-4444.
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 on 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.