Portfolio for a crashing market
Three weeks into 2022, the S&P 500 has dropped more than 8%, 10-year rates have risen, the highest inflation we have seen in decades and people's concerns have soared with it.
We invest for the long-term but you can't exactly rejoice at your dwindling portfolio returns. During times like this, I take a step back and see whether I have missed something and if there are any serious changes to be made to the portfolios. Doing a top-down macroeconomic analysis, there is nothing that signals a bear-market, yet.
Despite the bullishness, the technical indicators say: risk-off and go into cash.
I believe the recent volatility is consistent with times when stocks begin to price in an accelerated timeline and magnitude for Fed tightening. The broader path in 2022 still looks to be a positive one.
But, what can you do about your portfolio now?
The Alpha strategy relies on a relative strength test to determine the best stocks going into the next month. The strategy rebalances once a month and then lives with those decisions until the next rebalancing date rolls around.
That once-a-month rebalancing has worked out reasonably well with our portfolios declining less than 1% compared to the S&P 500's 8% drop.
Let's assume this shift to cash based on technicals does stick. What does that mean? For investors with a long-term horizon who are content to follow the strategy as it was intended, it should be an ignorable bit of data. After all, the strategy was built to rebalance once a month and ignore the intra-month provisional picks that can change frequently.
For investors wishing to take a more active role in managing risk, the technical indicators represents a sea change. Your options are to...
- Ignore it, making the calculated guess that the portfolio will rally, or at least not suffer further declines through the end of the month, or
- Sell all positions and buy Treasury Bonds (SHY) and Dollar Index (UUP) - or simply hold cash within the next few days, or
- Hedge: hold some percentage of stocks and some percentage of cash.
In option #1, you run the risk of losing some money if the markets continue to decline into the end of the month. In option #2, you run the risk of missing out on potential gains if the market turns around in the next few days and begins heading up. And in option #3, well, you hedge your bets either way.
Obviously, this is a judgement call. As every investor is in a different life situation and has a different tolerance for risk, I can't offer a specific recommendation.
And again, for those investors who are in this for the long haul and would prefer to avoid such judgement calls and leave it up to the strategy, do nothing and see how the chips fall when we rebalance the portfolio in the first week of February 2021.
The bottom-line: The markets will recover from this decline and go on to rally higher. All of the macroeconomic indicators and most of the technical indicators point towards this market continuing higher. I will be sticking to the strategy and holding my positions for now: option #1.