This Is Not the Time to
Go to Cash
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.”
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).
What Has Polaris Wealth Done?
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.
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.