Stocks Are Down Ten Percent, Now What?

This past week the S&P 500 traded ten percent below its all-time high set just a few weeks earlier on September 21^st. This letter also marks the one year anniversary of my letter entitled Top of Tops. Why wait until year-end to write the year in review when an anniversary will do.

Last November we were well into the Bond Bear Market that began in 2012, yet few talked about it or even noticed. We have been keeping score using the US Treasury ten year note which hit 2.01% on September 8^th, 2017, 2.47% a few weeks later on October 27^th and traded October 9, 2018 at 3.26%. Indeed bond yields are running higher, sending longer-term bond prices ever lower.

The bellwether thirty year US Treasury bond posted a low of 2.63% September 8^th, 2017 and recently traded at 3.44% on October 9, 2018. A year later we have seen significantly more analysts, pundits and investors join the bond market bear camp but as I said last month, interest rates are rising so slowly (so far)  as to only minimally affect overall fixed income investment returns.

This is not true with respect to stocks where October marked a quick and painful reversal for all stock indices. Last November I wrote “As stock indexes fall, more attention will be paid to rising bond yields. You won’t be surprised; we’ve been talking about the turnaround in bond prices for years now.”

Lo and behold, stock investors are looking for something to blame and bonds are an easy target. Yes, interest rates are up. But interest rates had risen substantially as stocks hit new highs earlier this year and when the S&P hit its new high September 21. So what is it: rising interest rates cause stocks to hit new highs or rising interest rates cause stocks to swoon?

The reason why both bonds and stocks are selling off is irrelevant. The fact that they have is important. For bonds, higher yields have been a fact of life since I called the end of bond bull market in 2012. This fact girds our approach to how we should invest that portion of our assets deemed cash and fixed income.

For stocks, I forecast excitement for stocks to propel a new rally in August 2016. It was this rally, one to remember, that took me to the November 2017 Top of Tops level and what I believed to be the end of the stock bull market similar to 2012 for bonds. The levels then were 23,500 for the Dow, 2,588 for the S&P 500 and 6,750 for the NASDAQ. Two swoons so far in 2018 and I am still wrong. But like this year’s bond market performance, a whole lot seems to be happening even while the net change is basically flat.

Here is what is important. Both bonds and stocks are in bear markets. These are not short-term bear markets, but rather long-term moves to correct the excesses of decades of long running bond and stock bull markets. While short-term trading opportunities will undoubtedly unfold, the primary direction of market prices for both bonds and stocks is down.

Diversification may not help you as volatility increases because the price trend for both stocks and bonds is lower. Your asset allocation pie chart should not show many slices in a bear market; the one pie should be labeled cash.

As a client of The Select Approach^TM you are very familiar with what cash is. Our approach is to use the municipal bond market as our means of investing in cash, also known as Cash Alternatives, because it offers a method I have found to  invest in low leveraged, high quality credits that mature in your account. Only fixed income (bond) instruments mature and if your investment doesn’t mature or matures further than you can throw it, then you might need to reevaluate its place in your portfolio.

I am working every day to invest your cash in a manner consistent with our approach. When you sell other assets, you are going to need more cash and this is what I help you with.

We are only down ten percent in the S&P 500 as of last week. I don’t know what your threshold level of pain may be, but I can tell you, as I did in 2012 for bonds, that we are in the (very) early stages of a long-term stock bear market. Diversification is not an option. Cash and its alternatives are your options.