Putting the Markets in

Perspective



My biggest concern is that sentiment might turn from being bullish to bearish. As we saw in 2018, irrational behavior can still negatively impact the stock market, even if there is nothing fundamentally wrong with the economy or the markets.

Jeff Powell | CIO, Managing Partner Tweet
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With the S&P 500 down 2.2% intraday, we are seeing an escalation of fear with each downtick in the market. Rarely do I write these types of education pieces using intraday information, choosing to have end of trading day data to provide the most complete information possible at the time. Given the heightened concern being expressed by investors I felt it worth getting this out faster rather than having this complete information.

Is This Historical?

Not at all. The S&P 500 is currently at 4,335. That’s just 201 points off of the all-time high of 4,536. This means the S&P 500 is only down 4.45% from its all-time highs.
To put this into proper perspectives, most market years will experience four separate corrections of five percent or greater, with one of those corrections dropping more than ten percent. The average intra year decline, from 1980 to present, is 14.3%. The markets have provided a little over an 11% average annual return during this time period. The take away should be that the markets have historically been more volatile than what we’ve been experiencing recently and that a 4 ½% correction is nothing in the bigger scheme of things.

Breaking Down the Markets

While the S&P 500 had been generally going up this summer, large-cap value had done absolutely nothing since May (see the graph provided).

This was due to sectors of the markets that had been driving the large-cap value markets up, began giving back some of their returns. Energy, which had the best performance of any sector in the S&P 500 during the first half of the year, is down almost 14% this quarter. Financials, the largest sector in the large-cap value segment of the market, is flat for the quarter. Industrials, another high flying first half value sector, is not down a little over 4% for the quarter.

Large-Cap Growth, which had not really done much for investors in the first four months of the year, surged from May until early September.

Much of this surge was due to large communications services and technology names like Microsoft, Apple, Nvidia, and Facebook. The consumer discretionary sector also helped push large-cap growth higher, with companies like Target, Nike, Tesla, and Lululemon pushing the index higher.

Why Are the Markets Dropping?

There are a lot of unknowns that are weighing on the markets, during this seasonally challenging time of the markets. The biggest things weighing on the markets are inflation due to government stimulus, supply chain disruption, and China.

We have seen inflationary pressures rear their ugly head due to all of the stimulus being thrown at our economy. While this stimulus has absolutely helped stop the watershed drop in our economy last year, it has come with some unintended consequences. The consumer price index, which measures inflation, has shot up to levels we have rarely seen over the past several decades. While the hope that this current inflation is temporary, the jury is still out.

As we’ve written about extensively and talked about in our podcasts, our government has been buying bonds as a way of protecting our economy. Over the past 18 months, the U.S. Federal Reserve Bank (“the Fed”) has purchased over $4.5 trillion in bonds and mortgage-backed securities (MBS). They are currently buying $120 billion in treasuries and MBS each month. The Fed has been doing this to create demand for this fixed income, forcing prices up and yields down. The Fed has begun talking about “tapering,” or cutting back, the amount of treasuries and MBS they are going to buy each month. Tapering would cause a rise in interest rates, which could slow down our economy.

Another concern that is influencing the markets is the continued supply chain disruption due to the recent spikes in COVID. While worldwide vaccination rates continue to climb, the delta variant has proven to be problematic to fully opening economies worldwide. The result has been disruption in the production of goods throughout the world. These disruptions have impacted everything from microchip manufacturing, to construction supplies, to food supplies. The cost to ship a container of goods from Shanghai to Los Angles is up 1,300%. The ripple effect has negatively impacted corporate earnings and caused inflation, neither of which is good for the stock market.

China’s government has done some very irrational things since the COVID outbreak. I’m not talking about how they treated the doctors who originally found COVID, or the strict shelter-in-place mandates, or how they refuse to admit the true number of people in China who contracted and died from this pandemic. In recent months China has placed restrictions on online gaming (people younger than 18 years old may only play online games from 8pm to 9pm on Fridays, Saturdays, Sundays, and public holidays), have placed major restrictions on who and when students may use tutoring services, restricted advertising of gambling destinations like Macau, and today the market reacts to the fear that Evergrande Group, a debt-laden property giant in China, may collapse (impacting the banking system in China, and beyond).

As you can see from the graph provided, the Chinese stock market is down more than 18% for the year, due to this erratic behavior. Investors fear that China’s mandates will further slow down their economy, sending a ripple effect through the world’s economy.

What is Polaris Wealth Doing?

Prior to today’s movement, we were already sitting in some cash. The Polaris Wealth Growth and Income strategy, with the largest amount of client assets, was already in an 8 ½% cash position going into today. All of our other strategies had some cash on hand. While I typically don’t like to sell into markets that are down as much as our markets are today, we have chosen to sell additional positions across all of our strategies to get a little more defensive.

Now is not the time to get extreme with your portfolios. At the moment, we are dealing with a minor pullback in the markets. We are using this pullback to raise some cash and preparing to redeploy this cash when things calm down. That said, we are prepared to sell additional positions if the markets wish to retreat further. As we’ve discussed in our quarterly newsletters, our current markets are overvalued. They are susceptible to a pullback. My biggest concern is that sentiment might turn from being bullish to bearish. As we saw in 2018, irrational behavior can still negatively impact the stock market, even if there is nothing fundamentally wrong with the economy or the markets. Remember, the markets can remain irrational longer than you can remain solvent. Our investment committee is working diligently to make the incremental changes to our strategies to temper risk but to due so clinically and strategically.