This Is Not the Time to

Go to Cash

Fear can be a good thing. In primitive times it kept you from being eaten alive. While much of that same DNA courses through our bodies today, our “fight or flight” reactions can often lead to catastrophic financial results. I have seen the smartest professionals make the most irrational decision.

Jeff Powell | CIO, Managing Partner Tweet

On March 18, 2020, I wrote a Polaris Perspectives piece encouraging clients to not make requests forcing us to go to cash in their portfolios. I went on to say that this type of request was based on emotions, a fear that the markets would continue to drop, and could hurt them financially. When I wrote this piece, the S&P 500 was down 33% from its high point and 25% for the year, closing at 2,398. The markets found their low three trading days later, at 2,237. An investor who had gone to cash at that point would have avoided only a 6.7% additional downside. Remarkably, less than a week later, the S&P 500 closed at 2,447 on March 24th and rallied through the rest of the year. The S&P 500 finished the year 56% higher than from where I told our clients to not force us to go to cash. The S&P 500 is down almost 21% for the year. The NASDAQ is down over 30%. Now is not the time to go to cash. We want to “buy low” not “sell low.”  

We are receiving a lot of calls and emails from clients, concerned about the market’s drop. Most simply want their hand held (which is understandable), but a few are requesting we go to cash. This is the wrong thing to do at this moment. Fear can be a good thing. In primitive times it kept you from being eaten alive. While much of that same DNA courses through our bodies today, our “fight or flight” reactions can often lead to catastrophic financial results. I have seen the smartest professionals make the most irrational decision. They follow the Cycle of Emotions into panic mode and sell at the worst time possible.
Most individuals make horrible investors because they allow their emotions to drive their investment decisions. They invest when they feel comfortable, and they sell when they don’t feel comfortable. DALBAR has studied individual investors for years. Their 2020 study perfectly illustrates my point. The average individual investor, who is allowing their emotions to get the better of them, has a return that barely has outpaced inflation.

This Time It’s Different

One of the pushback comments that I hear from clients when advising them from going to cash is the comment, “This time it’s different.” And they are correct. I’ve worked in the financial industry for over 30 years. Every major market correction I’ve experienced has been different. Just look at how different this drop has been as compared to the COVID correction in 2020. Do you even remember what made the markets drop 20% in 2018? We had a 16% drop in 2010 followed by a 19% drop in 2011. Not bear market movements but enough to rattle most people’s nerves, especially after the Great Recession’s chaotic drop 66% drop from October 2007 through March 2009.

Intra-year declines and volatility are part of investing in the stock market. The average intra-year decline for the S&P 500, from 1980 to present, is 14%. 24 out of the past 42 years the S&P 500 has dropped more than 10% intra-year, with nine of those times turning into more than 20% “bear market” correction. You should expect a double-digit intra-year correction every two years, with one of them dropping into bear market territory (down more than 20%) once every four years. Those are some ugly statistics. Let’s flip the narrative. Even with the statistic I just wrote, the S&P 500 was up more than 75% of the time and provided an annual average return of over 11%.

Why are the Markets Falling?

We are dealing with very unusual times. You could chalk it up to COVID and lockdowns in China. The war in Ukraine. The sanctions on Russia have sent oil and gas prices up dramatically. Russia is a large world supplier of oil, natural gas, several types of fertilizer, wheat, copper, nickel, and iron. China’s lockdown and Russian sanctions are creating shortages and continuing our supply chain issues. Throw in some questionable decisions on U.S. economic stimulus and it all has led to the highest inflation levels in 40 years. Inflation can cut into corporate profits, lowering their earnings growth and the price, especially for growth-oriented companies. Sentiment has turned very negative, leading to baby and bathwater being thrown out. Great companies are seeing their stock prices plummet, giving us future buying opportunities when things calm down. We don’t want to “catch a falling knife.”

Inflation also impacts the prices of bonds. Typically, an investor can find safety by moving some of their allocations from stocks into bonds. Not the case this year. As we’ve written about extensively, as interest rates go up, bond prices go down (see illustration).

June 2022 Inflation Rates - Polaris Wealth Advisory Group

Long-term treasuries were the best performing asset class during the Great Recession. The iShare ETF covering this index is down more than 25% for the year (see graph). Not exactly the protection investors were looking for when investing in it.

What Has Polaris Wealth Done?

Polaris Wealth has done what it has always done, acted tactically. We’ve lowered our exposure to higher-risk stocks, moving into what are considered more defensive sectors of the stock market. We’ve lowered our exposure to bonds in strategies that held bonds. We’ve added significant cash positions at different points of the year. Unfortunately, we haven’t been rewarded to the same extent that we have in days past for our efforts. Our strategies are still the same. The decision-makers are the same. There’s just been an increased correlation between high and low risk investments, punishing all of them equally. We are confident that sense and sensibility will return, and that our strategies will continue to provide our investors with long-term value.

What Makes the Market Turn Around?

The same thing that is driving the markets down should provide us guidance on the way up, and that’s inflation. There has been some criticism on how Fed Chairman Jay Powell and the Fed have handled inflation. The Fed and the Treasury had a tough job during COVID. They’ve had to balance government stimulus programs with their own work to keep the economy from falling back into a recession while also limiting inflation. 

There is no “playbook” on how to balance these things during a worldwide pandemic. Most economists felt that the lesser of the two evils was a little bit of inflation. As you can see from the chart, inflation didn’t really start rising until 2021 and appeared to have leveled out in the 5.4% range.

Looking back now, it is easy to criticize the Fed for moving slowly. The Fed was buying U.S. Treasuries in the open market to create demand. Higher demand pushed prices up and yields down, making borrowing cheap (thus stimulating the economy). The Fed didn’t begin tapering this practice in December of 2021 and ended their bond purchasing program entirely in early March 2022. The Fed only raised rates 0.25% (25 bps) at their March 16th meeting. Inflation was now approaching 8%. They raised rates another 50 bps on May 4th. 

We are now sitting with an 8.6% inflation rate (see chart). We are at levels we haven’t seen in forty years. It is expected that the Fed will now raise rates 0.75% at their June 15th meeting to try to knock down inflation.

During the Great Recession, the Fed was criticized for lowering rates from 1% down to 0%. The argument was it really didn’t do anything to stimulate the economy. I think that one could argue the opposite. Raising rates from 0% to 1% does nothing to combat inflation. Fed Funds’ current target rate is 75 to 100 bps. A 75 bps move would take us to a target rate of 150 to 175 bps. Expect the Fed to get more aggressive. Fed Futures for the December 14, 2022, have the highest probability of rates being at 3.75% to 4% (see chart). 

Once there is any sign that inflation is coming under control, investors are going to come flocking back into the market. The Fed still has a tough job ahead of them. Raise too much, too fast, and they could send the U.S. economy into a recession. Don’t raise enough or move too slowly and inflation could continue to rise.

Conclusion

Most clients of Polaris Wealth have had a financial plan created for them. These financial plans have Monte Carlo simulations in them and take into consideration markets exactly like we are going through right now. While it is never fun being an investor in a down market, we’ve planned for it. If you haven’t had a financial plan run for you, please take advantage of this service immediately by calling your adviser at Polaris Wealth. Volatility can be scary, but we will get through these markets and recover.

This is the 15th Bear Market since World War Two. As of today’s close, the S&P 500 is down 21.33%. I thought it would be good for you to see the statistics of these Bear Markets and their eventual recovery.

Post-WW2 S&P 500 Bear Markets* - Polaris Wealth Advisory Group
Once the markets are down 20%, the median number of days until the end of the Bear Market is 43 days, with 8.6% additional losses until the end. This means we are closer to the bottom than the top. The median recovery a year later was 23.90%. Going to cash right now would be falling prey to one of the most classic mistakes investors make, letting their emotions dictate their investment choices. While recovery didn’t happen in all cases, they recovered 78.6% of the time. If those statistics are good enough, let’s take it a step further. Where do you think the market is going to be three years from now, five years from now, or even ten years from now? Will they be higher? Will you regret selling now and missing out on the recovery? We are here for you. Please reach out to your Polaris Wealth financial adviser. We welcome helping you through these difficult times.

As always, I welcome your questions and comments.

Jeff Powell

Jeff Powell | Managing Partner & Chief Investment Officer
Polaris Wealth Advisory Group