How bad was January?
- The Nasdaq is down nearly 12%, certifiably in correction territory. If Monday doesn’t save it, it will mark the worst decline for the index since October of 2008.
- The Russell 2000 is down more than 12%. Having peaked in November of last year, this small-cap index is now in bear market territory with over 20% in losses.
- The S&P 500 is down 7%.
- The Dow Jones Industrial Average is down over 4% for January.
How are the popular hedges holding up? Some better than others, but actual green is elusive. TLT, the long-dated Treasury fund, is off 3.4%. JNK, the high-yield corporate bond fund, is off 2.8%. AGG, the aggregate bond fund, is down 2%.
Gold down. Silver down. Bitcoin off 17.0% for the month (bitcoin may/may not have a place in one’s portfolio, but when someone suggests crypto as a hedge to equities, run for the exit).
All in all, it was a rough month for investors across the board, with few places to hide. Wall Street veterans say they haven’t seen this kind of sustained volatility since the dot-com bubble burst back in 2000 or the financial crises of 2008. Most were caught flatfooted with the severity and breath of the downturn…
Two schools of thought:
… but not everyone. Among those not surprised: influential money manager Jeremy Grantham. In an interview with Bloomberg this month, he said we are in the midst of only the fourth "super bubble" in U.S. History, with inflated prices in stocks, housing and commodities due to the Fed keeping interest rates too low for too long. He predicts an imminent crash and advises exiting U.S. stocks altogether.
Other money managers call January a “natural recalibration” after years of particularly strong market growth have stretched the valuations of some companies, most notably tech companies, pandemic darlings, SPACS, and meme stocks.
Indeed, over the past few months the air has come out of names like Peloton, Zoom Video, DocuSign, and PayPal. And meme stocks like Gamestop and AMC Entertainment, that introduced a whole new generation of traders to the market, are down 70% and 75% respectively from their high-water marks in 2021.
Mike Santoli, Senior Markets commentator for CNBC, says the recent stock market action “fits the profile of a proper correction process noisily running its course.”
So, is Grantham right, in which case the carnage has only begun for the broader market? Or is this, in fact, a recalibration and a proper correction noisily running its course? And if the latter, with so many stocks trending below their 200-day moving averages, has a floor been put in?
No one knows for sure, though the consensus leans toward a recalibration/correction. But few are willing to stick their neck out and call this the bottom.
What should investors do?
With many investors, it’s easy to let emotions take over in times like this. But we have an advantage. At the heart of each of our strategies is a cold-hearted algorithm with nerves of steel. Those strategies pick their funds once a month and ignore the next 29 days; the flailing arms, the gnashing of teeth, the news clips and breathless sound bites that drive 1,000 point daily swings in the market.
I envy the machines.
The nimble among us can trade strategically around the edges of the strategies and sometimes boost returns a bit. Like rebalancing mid month if provisional picks show a switch from an equity fund to a safe harbor asset (cash or bonds). Or the converse; rebalancing if provisional picks show a switch from a safe harbor to an equity. These are calculated risks, of course. Hedge that risk by only rebalancing a portion mid month, leaving some percentage in both camps – safe harbor and equities.
Then again, for investors with a long-term horizon and a moderate risk appetite, simply following the once-a-month rebalancing trade for your strategy (or strategies) gets the job done. And with minimal fuss.
The takeaway: Have a plan and stick to the plan.
** What does protection look like? At the extreme, it’s cash. As I mentioned last month, it’s OK to hold some cash. Cash is, in fact, a position. It means you’re prepared to act when circumstances better align with your risk tolerance.
Protection can also mean an overweight position in a model built for protection (i.e., Bond Bulls, Lean Muscle, The 12% Solution). It can mean putting multiple strategies to work in a portfolio, especially when those models tend toward an inverse relationship with each other, or focus on different asset classes or market sectors. Think Bond Bulls and American Muscle. Or Global Trader and The 12% Solution.
Because each strategy uses a slightly different mechanism to identify market risks, and because each can employ different funds representing different market sectors (although there is obviously some overlap), there is beneficial diversification at work when using multiple strategies within a portfolio – helping to reduce volatility and max drawdown.
Finally, protection can mean keeping an eye on the provisional picks during the month. These can provide a heads-up on potential trends -- and breakdowns of existing trends. Look for asset class shifts (a switch from an equity fund to a safe harbor asset like cash or bonds, or the contrary). See if such a shift holds up for a few days. Not every such move is a trading opportunity or justifies a rebalancing, but information is power.