Hi everyone,

Normally this time of year there is very little to write about. Not the case right now. I may have more to say right now than any time over 7 years and the 350 or so weekly blogs I have written.

I want to start by wishing you all Merry Christmas and Happy Holidays. I hope you are enjoying time with friends and family over the next few days.

I am going to break this down in 3 parts:

What has happened in the market these past few weeks and the damage the market has incurred in December.
My opinion in light of current market conditions.
How we are currently invested, what we have done and what we plan to do next.

In The Market...

The S&P 500 fell -7.1% last week. Let's look under the hood:

The -7% decline is the worst for the S&P 500 in more than 7 years. The S&P is down -9.7% for the year with basically one week left. Barring a Christmas miracle, it will be the first down year for stocks since 2008 (2011 and 2015 were essentially flat years).

Last week I posted a chart of the S&P and emphasized how stocks were teetering on the brink of a potential drop. That was not meant to be a prediction, but more so an illustration of the risks that persist. There are multiple risks that I have consistently highlighted dating back to October. Here is that same chart from last week, updated accordingly with the fat red candle on the end that reflects last week’s S&P decline:

The S&P 500 fell through the trap door of those two dashed lines (1 and 2). Those lines coincidentally converged at a price level that may have provided support for stock prices to bounce. It did not. When that support is not held, prices can fall quickly as they did last week.

The headwinds that led to this have been there for weeks. A variety of statistical measures implied that this could happen, from falling moving averages to dwindling price momentum (via Relative Strength). It does mean it was destined because the market has a way of surprising. But the warning signs were there and is the reason we have been sitting heavily in cash the past few weeks.

So now what?

There are two problems I keep coming back to, one of which is more short-term and the longer is more long-term. In the near-term, I get the sense that most investors remain too complacent. Whether that is because they are focused on the holidays or they think that stocks will quickly bounce back like they have at other points in the past decade or they simply do not want to think about it whatsoever. Whatever the reason, it feels like most people are not paying attention. This complacency is one of the reasons I think the market has further to fall in the weeks ahead.

The longer-term problem is that we have shifted from a market where investors are looking to buy when prices drop to a market where investors are looking to sell any rallies. This difference is stark. The whole idea of a rising market trend is that investors are itching to buy when stock prices fall. This leads to prices rising higher and higher over time. In contrast, when the market is damaged like it is, many investors cross their fingers that they can make back something before selling. This leads to prices falling lower and lower over time.

Mark my words, there will be rallies. Significant ones. But they are likely to be followed by more downside volatility.

Here are some of my other thoughts regarding current market conditions and investing behavior, in no particular order:

If someone says they predicted this market drop, take it with a grain of salt. I won’t refute that they may have said it, but I would question how many other times they previously said as much in recent years, only to be wrong. On a long enough timeline any prediction can come true. Most people use hindsight only when it works to their advantage.
Evaluate others not on what they say, but what they do. If someone has believed that the market would plunge, I would be eager to see what they actually did about it within their investment accounts. If they are still heavily invested in stocks or stock-heavy funds, they are contradicting themselves.
If this month is causing you to reevaluate your risk tolerance, good. That does not mean you necessarily need to change anything, but it is important that the risk tolerance you say you are comfortable assuming is actually something you are willing to tolerate.
Focus on the future. You cannot affect what has already happened. With investing, if you dwell on the past without learning anything tangible, it will likely result in making a poor, emotionally charged decision. This is why most investors buy high and sell low.
Have a plan. Be ready for when the time comes. I spent time this past week generating a list of stocks and funds that are on our “buy list” for when market conditions improve. That way we can hit the ground running when it comes time to reinvest.
Your goal should be to capture gains and limit losses. Your goal should NOT be to maximize gains and prevent losses. Notice the difference? For instance, if the market is falling you need to realize and accept that you will lose money. But it is about softening those blows, not eliminating them. If you focus on eliminating them you will be more apt to respond irrationally.
Focus on the long term, which is months and years, not days and weeks. If you are watching your account every day or even every week, it accomplishes very little and will only stress you out.
Do not stop investing. Keep contributing to your retirement accounts. It does not mean you should necessarily buy stocks right now, but it is good to keep the cash contributions coming so that you maintain a consistent behavior.
Buy-and-hold investing is a fine plan if you are comfortable with the volatility associated with the investments you own. If you are not, then it may not be the best plan because when the market falls you rely on hope, not process.
The market can fall -10% or -20% in a calendar year and it does not mean we are having a repeat of 2008. Different times. Different market conditions.
Are we in a bear market? I don’t know and I don’t care. It doesn’t mean anything tangible. I say “bullish” and “bearish” to distinguish between positive and negative, but I don’t get into defining whether we are in a bull market vs. bear market.
If you hear that stocks are “undervalued” or “overvalued”, disregard it. Supply and demand is the only thing that determines price and is the only thing that matters.
Forget politics. In the same way that I did not credit President Trump when the market rose throughout 2017 I do not blame him for the market falling today. If you disagree with me that is fine, but you are wasting your energy because you cannot prove it. We have an innate tendency to want to explain why things happen. Politics are an easy target for that. But ultimately you cannot know what motivates buyers to buy and sellers to sell, so it is a fruitless exercise to credit/blame politicians.
Guess what? In the long run, stocks do go higher. As I wrote back in February and again in October, it likely would be a bumpy ride for a while. But unless you refute 100+ years of market history, eventually the market will recover.

What we are doing: As mentioned we have been holding a significant cash position across most accounts, so December has not been as bad for us as it has been for others. Most accounts continue to be anywhere between 50% and 75% cash. With that said, we are not 100% cash so some level of loss is likely when the market tumbles like this.

We continue to hold a Health Care sector fund (XLV), which turned out to be a poor buying decision in hindsight. But I can live with it given the high percentage of cash we are holding and the fact that Health Care, relatively speaking, remains the healthiest segment among the 10 major stock sectors.

We cut our position in the high-dividend S&P index fund (SPYD) very early in the week. So, while half of that position bore the brunt of the full week, the half we sold was fairly unscathed.

The bond market has perked up in the past few weeks, as it often does when stocks decline. We added a small position in a long-term U.S. Treasury bond fund (SPTL) at the very end of last week. In the event that the stock market moves lower, there are relatively good odds that more investor money will flow into conservative investments, such as Treasury bonds. However, because the near-term odds of this are not quite as bullish as we would like to see just yet, we kept the size of the purchase pretty modest. We will look to add to this position if bond market conditions keep improving as we think it may.

For accounts that own individual stocks, we have had a couple misses in the past two weeks but have done an okay job of limiting those losses.

In Our Portfolios...

What's New With Us?

Enjoy the holidays. If you have any questions, we will be working all week (Christmas aside). I deeply appreciate the trust you all place with us to make wise investment decisions. In doing so we will continue to levy our best judgment based on the rigorous amount of analysis that goes into our investment process.

Have a great week!

Brian E Betz, CFP®
Principal

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