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For many of you the recent downturn to June 30th levels is a bit disconcerting

September 26, 2022

For many of you the recent downturn to June 30th levels is a bit disconcerting. I understand the feeling. This is a troubling time and whether we like what the Fed is doing or agree with their past mistakes, does not change the current environment.

A friend in the business gave me an analogy: We all know that there is a 100% guarantee that it will snow in Colorado. We just don’t know when. That is great way of looking at stocks. According the international firm Dalbar, the markets have a 30 year track record of a 10.5% average annual return. So we don’t know when these markets will recover, but we do know that they will. We also know that the upturns normally last 2 to 3 times the length of the downturns.

My point is that we either try to time the markets or stick it out for the long term. In 40 years in this business, I have never been able to effectively time the markets, nor has anyone else. For now, I want to stick with the current growth stock exposure through the third quarter earnings and election. Then I will assess whether to switch some of our money to value stocks, that typically do better in downturns.

My objective is to take advantage of any growth in the fourth quarter and then make the shift to value. I will do this because I don’t believe the Fed is going to stop increasing interest rates in the next 3 to 6 months. And it is my belief that the Fed is what is causing this downturn, not valuations or weakness in real estate as we experienced in the 2000 and 2007 downturns.

Stocks are poised to move up once the Fed takes it hands off of interest rates. What we don’t know is when that will be. As a result, we will take a more defensive position after the next two months. Hopefully we will see some upturn over that period of time to lock in as we switch to value.

Until one of our two scenarios plays out – a recession or the realization the Fed has pulled off a soft-landing – US equities are likely to be in a trading range with potential bear market rallies that come and go.

I still expect the much more likely scenario is that a recession will arrive sometime in 2023 (possibly early 2024) and that stocks will remain in a bear market until the recession hits.  Why a recession?  Because the Federal Reserve will have to get tight enough to reduce inflation toward its target and a monetary policy that’s tight enough to control inflation is going to send the economy into a recession. Best case scenario would be a recession in the second quarter of next year and a rally in the second half of next year.

A couple of things to keep in mind.  If you’re a very long-term investor who doesn’t want to time the market, none of this discussion matters much.  Just maintain your normal allocation to stocks and don’t be shy about continuing to buy stocks at your normal intervals.  That way you’ll be buying at low stock prices, too, and stocks should be worth substantially more when you’re spending down assets in the far away future.

I believe there is risk in timing the markets, so I am not recommending that strategy, although that is an option for investors. For now, we know it is going to snow (markets rising) but we just do not yet know when.

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