“The Cuervo Gold
the fine Colombian
make tonight a wonderful thing”
--Hey Nineteen, Steely Dan, 1980
That didn’t take long. Remember all of that tough talk from the new sheriff at the Fed? Three interest rate hikes in 2019? Balance sheet reduction on auto pilot? All it took was two tough months in October and December after a decade of historically steady gains and poof, all of that tough monetary policy talk is gone. Turns out the new Fed Chair is no different than the ones before him. Hey ’19, forget about the increasingly nasty hangover of mounting financial instability and geopolitical angst looming tomorrow. Instead, pour the monetary Cuervo Gold into the punch bowl, light up those fine liquidity flows, and make trading stocks today a wonderful thing.
“Where the hell am I?”
--Hey Nineteen, Steely Dan, 1980
You’ve just broken back above key technical resistance. The good news for stock investors today is that the S&P 500 Index at just over 2700 has broken back above its ultra long-term 400-day moving average at around 2660, which had been stubborn resistance since it was broken back in early December until the Fed took to the podium yesterday.
Next up is the 100-day moving average at 2712 and then the 200-day moving average at 2741. Whether the S&P 500 can overcome these key resistance levels remains to be seen. But thanks to the Fed, the stock bull market remains intact and the momentum remains to the upside. Even if you think the U.S. stock market is built on a foundation of sand, this is why it is prudent to not only maintain a measurable allocation to stocks, but also to be patient and deliberate in making adjustments to any such allocation to stocks over time.
no we can't dance together
no we can't talk at all”
--Hey Nineteen, Steely Dan, 1980
But here is the lingering problem for investors as we continue through 2019. Yes, the Fed has suddenly got the back of the U.S. stock market again. Fantastic. But for how long. Because here’s the thing. Stock valuations are still rich by historical standards at more than 20 times earnings. Take out the artificial boost on an after-tax basis from the recent tax cuts, and they are even more expensive. And all of the talk about how awesome the economy was going to be to justify all of the stock gains that we have seen up to this point apparently is failing to materialize. For if the economy was still at best awesome or at least still on track for reasonably solid economic growth as far out as the eye can see, why then have those charged with overseeing and influencing the direction of the U.S. economy in the Fed suddenly caved from three rate hikes to none and balance sheet reduction auto-pilot to openness about expanding the balance sheet once again over the course of about a month? Did the economic outlook really turn that dark so suddenly? If it did, I’m having real trouble seeing it in the data. Or do our monetary policy makers with the dual mandate of full employment and price stability once again reactively succumb to the pressures that come with a few tough trading days on Wall Street? Regrettably, it appears to be the latter. And if the fate of investing comes down to the caprice of a few powerful carbon based human decision makers on any given trading day, not only is this difficult to model, but it presents risks that may simply no longer be worth it for those with lower risk tolerances.
That's 'Retha Franklin
She don't remember
The Queen of Soul
It's hard times befallen
The sole survivors
She thinks I'm crazy
But I'm just growing old”
--Hey Nineteen, Steely Dan, 1980
All of this fuss may seem silly for investors that are new to the market. The Fed caved again! What’s to worry about? Pour yourself a drink, get long stocks, and party on! But this is not a prudent solution, particularly for the sole survivors. For those that have been in the markets for more than a decade or two, many of which who are either entering or now well into retirement, remember like yesterday those days of markets past when a dovish turn from the Fed or the unsheathing of a bazooka by the Treasury was supposed to bring with it a bullish turn in the market. Instead, these turns marked the continuation of the end for bull markets that simply started to crumble under their own valuation and speculative excess weight.
For example, the Fed stopped raising interest rates in 2006 and started cutting interest rates in September 2007. The U.S. stock market set a new all-time high a month later in October 2007. And the Fed kept cutting interest rates by nearly five percentage points over the course of the next year. Yet it didn’t stop the S&P 500 Index from shedding nearly -60%.
Another example, the Fed stopped raising interest rates in May 2000, roughly two months in retrospect after the bear market in stocks was already effectively underway. The Fed subsequently cut interest rates by more than five percentage points over the course of the next three years, in part with the stated objective of encouraging housing demand in order to stimulate not only the U.S. but the global economy and its markets (great plan – worked out swimmingly). Yet this did not keep stocks from falling by more than -50%.
Those that have been in the stock market over the last couple of decades remember still remember these past episodes like they were yesterday. And the dual shocks of January-April and October-December 2019 have served as a fresh reminder for those that may have forgotten that these swift and unforgiving downside risks are still churning actively under the surface of a market that until recently seemed otherwise placid. And for many investors, they simply cannot afford to go down fifty on their savings for a third time in twenty years.
Make forever a wonderful thing. So what is a risk averse investor to do? They were likely in the process of scaling back stock allocations until the Fed happened yesterday. Do they dive back into stocks to protect against missing out on the thrust above 3000 on the S&P 500 Index? But what if this latest dovish turn by the Fed is nothing more than a repeat of 2000 and 2007. Should they be selling more instead? How should the risk averse investor react!?! The answer. They shouldn’t react at all.
The key to successful long-term investing is establishing a disciplined strategy and sticking to it over time. When you get down to it, investing in the stock market is nothing more than a savings vehicle that has the potential to provide you with a higher rate of return versus what you might otherwise generate from a bank savings account, and the cost for this higher rate of return is the uncertainty associated with the value of your principal investment at any given point in time. As a result, your investment decisions including those related to the stock market should be driven by the ownership of securities with a fundamental profile that make sense for your specific return expectations, risk tolerances, time horizons, income needs, and underlying beliefs. Whether the stock market is going up or down on any given day because some policy big wig in Washington completely changes his or her mind over the course of a month’s time should not drive your decision making. Such outcomes should be considered, but carefully, deliberately, and on the margins over time, not reactively or all at once.
The dandy of Gamma Chi. So where should an investor that wishes to be patient and deliberate but still wants to allocate to the U.S. stock market focus their attention today?
First, focus on value. In particular, focus on U.S. large cap value. Why? The performance disparity between U.S. large cap value and U.S. large cap growth stocks has been historically wide by orders of magnitude over the last many years. And while the overall U.S. stock market remains expensive, many pockets of the U.S. large cap value space have become inexpensive. And as the bursting of the tech bubble showed nearly two decades ago, large value stocks can still perform well even when their large growth counterparts are struggling mightily.
Second, focus on defense. A reassuring point for risk averse investors in today’s stock market is that the stock market segments that are trading at the most discounted valuations are also in many cases the most defensive as well. In other words, these are the stocks that typically hold steady if not rise when the broader market is falling. Consider the dandy of gamma chi in pharmaceutical and biotech stocks. Or consider selected household product and food stocks, many of which are trading at discounted valuations only seen over the last three or four decades during the extreme depths of the financial crisis.
Position for defensive upside even if the broader market slides on down. Although the S&P 500 Index itself is expensive and may potential become even more expensive now that the punch bowl has been refilled with monetary Cuervo Gold, the U.S. stock market continues to offer even the most risk averse the ability to not just speculate but make dedicated investments in high quality defensive value names that are well positioned today to rise no matter whether the broader market shines or fades for the rest of 2019 in the wake of the Fed’s latest dovish turn. It requires extra work to find these names, but who ever said that stock investing should be easy.
Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners and Global Macro Research makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners and Global Macro Research will be met.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long selected individual stocks as part of a broad asset allocation strategy.