The Bear Ate Santa Claus’s Rally

 In Strategy Updates

Until recently stock indexes traded within normal correction territory – demonstrating more than normal volatility. However, as of late, global stock indexes have declined beyond correction levels and sectors of the market have fallen into what we consider bear market conditions. Investors would be wise to pay attention to this greater than normal decline in stocks, as it may very well be the precursor to a continued downward spiral. As you know, we have been sellers of stock for the past few months, which has reduced your stock exposure significantly. Most importantly our selling was focused on the banks, technology and industrial companies – which have fallen the most in this recent selloff. Thankfully this reduction in stock exposure – and of the most vulnerable stocks – has and will continue to protect your portfolio should the market decline become more significant. Keep in mind when the market falls 5%, your total portfolio declines less due to these changes and our active risk management. So where do we go from here? Have stocks fallen enough? Let’s discuss.

In many ways the stock market is the economy. Though the past four quarters of economic growth have been stellar, the stock market is telling a different tale about the year ahead. This different and less bright future is tied to many issues including the Federal Reserve and their unwillingness (at least so far) to slow or halt interest rate hikes, tariff concerns, and geopolitical and global economic debt levels. From our view, the stock market is beginning to discount one of two scenarios. Here are those scenarios and how we expect to get you through each successfully:

The global economy slows from recent 4% growth to 1.5-2% growth and avoids recession.

This scenario would cause corporate profit growth to slow – particularly for companies that require a fast growing economic backdrop: think banks, tech, industrial, energy and consumer discretionary companies, most of which we have sold for you in the past few months. However, a slower economic climate would allow a bull market of another kind to emerge – one we have discussed in recent Strategy Updates. It would be a bull market not led by the FAANG stocks, or the fast growing consumer discretionary companies etc., but rather companies in the sectors that have great profit growth regardless of the strength or weakness of the economy – think consumer staples, healthcare, utilities and select technology companies whose fortunes are not tied to strong economic growth. This is where the bulk of your remaining stock exposure lies today and so far these stocks are holding up quite well. If this type of “new” bull market can emerge in the next few weeks or months, we will be adding more of these types of great companies such as Proctor & Gamble and NextEra. Basically, companies with great balance sheets and brands that investors can be very successful owning should this scenario play out.

The global economy falls into a recession.

At a glance, global stock markets appear to be discounting a recession. All of the sectors that typically fall the most in a recession are doing just that. It is possible that the Federal Reserve has already raised interest rates too much and instead of trying to slow the economy in 2019, it may be headed to a screeching halt. The last interest rate hike earlier this week may have been the “straw that broke the camel’s back.” In this scenario, we want to shed all stock that would be negatively affected. Most of that work is already done as you have noticed from our selling. The good thing about recessions and bear markets is that they are rather short affairs. In fact, bear markets usually last just 6-9 months in which case we are already two months into this one. Should we enter this scenario, we want to keep your stock exposure much less than normal and in the kind of stocks that survive a tough economy. We will also buy short term fixed income and preferred money market funds to provide you with the best risk-adjusted return possible. The best thing about a bear market is that when they end there are tremendous bargains to take advantage of if investors have the cash and capital to do so – and given our strategy we will be well positioned.

As you know, we take risk management very seriously, hence our willingness to reduce your exposure in recent months. Though losing some portfolio market value doesn’t feel great, we have now put in place the ability for you to avoid any oncoming “catastrophic” declines that may be coming the market’s way. Always remember the “ugly math” – when investors lose 50% they have to go up 100% to get even! In that spirit we continue to use stop losses on the remaining positions in your portfolio – many of which are close to being executed should a bear market ensue.

In the event that all of the current risks dissipate quickly – a scenario we do not think likely – we have a list of more growth oriented stocks that we could easily and quickly add to your portfolio. However, in the current environment we will continue to play it “safe” rather than end up “sorry.”

All of us on the team wish you a safe and Happy Holiday Season. If you have experienced any significant changes in your financial situation please let us know.

Your Team at Main Street Research

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