NOW It's A Bear Market

Fed rate cut = “Aggressive Capital Preservation” time

The long-awaited Fed rate cut occurred at the end of last month. Actually, it was not long-awaited at all. Just a few months ago, the average Wall Street guru was expecting multiple rate raises by the Federal Reserve Board.However, in response to slowing global economic growth, tariffs, and a lack of inflation pressure, the Fed decided to take overnight rates down a notch. Their goal is to keep employment high, inflation at bay, and recessions in the closet. To longtime market-watchers like me, this seems more like a desperate attempt to stop the economic cycle from playing out. But that’s like trying to stop a 95 MPH fastball with your bare hand.I have written here in the past that a rate cut might be a temporary spirit-lifter for the market, if even that. More likely, history will play out as it did the past two times the Fed lowered rates for the first time in a while. That is, the first rate cut essentially serves as the official welcoming of the bear to the stock market.

Why the rate cut? And why now?

There are many theories about this. To me, the biggest concern about the rate cut is that it may signal that the economy could quickly decelerate, and the Fed knows it. After all, I have been showing you signals and indicators that hinted at the end of the economic expansion and the bull market since early in 2018. At the end of January, 2018, my proprietary Investment Climate Indicator (ICR) shifted from its second lowest level (Overcast) to its lowest (Stormy).Since that time, the S&P 500 has been about flat, as the chart below shows. The markethas gyrated a lot since that time, but it has made little upward progress.Now, the S&P 500 is not the entire market. So, there will continue to be opportunities for equity investors. They just won’t resemble the last decade, where you could essentially throw darts and make a profit.

The economy and your portfolio

I care a lot about what happens to the economy. I hope it continues to provide opportunities for people who want the jobs they desire. I hope that prices of goods we enjoy stay relatively stable in price, instead of getting more expensive all the time. I hope. But hope is not a strategy.Furthermore, the economy is not anything you or I can control. We have more control over how we invest. If you are like me, you believe that investing should not be over-simplified or “punted” to a “set it and forget it” approach used by so many. It follows that when the economy, interest rates and/or the stock market’s major trend changes, we had better recognize that. And we change with it, within the boundaries of whatever our specific objectives are.

Stormy turns to full-on bear mode

January, 2018 was a good time to start thinking seriously about this, and positioning yourself. The signs have been there before and since that time. Now, with the Fed doing exactly what coincided with the dawn of the last two major stock bear markets, are you going to ignore that? Or, are you going to continue practicing “Aggressive Capital Preservation?” That’s my term for the act of prioritizing keeping what you have, but carefully seeking pockets of opportunity. This is essential at a time when strong returns are no longer a “layup.” In fact, this is a time when capital can be destroyed, quickly.Major declines are bad enough by themselves. However, what is just as bad is the math of investment loss. Namely, that it takes so much more in percentage gains to recover from a big loss. That’s why my personal mantra is ABL – Avoid the Big Loss.

Fed cut rates, stocks drop big (2000 edition)

When the S&P peaked after the rate cut at the start of 2001, the market was already falling. 2000 had been a down year (like 2018 was). The market did did not recover its year 2000 high until during 2007.

Fed cut rates, stocks drop big (2007 edition)

And then, just when it seemed safe to go back in the water…it happened again.

What should you do next?

That’s a personal decision. But now that you know the history of the only 2 initial rate cuts in this century before last week, now you know what the potential risks are. In my own portfolios, I am emphasizing 3 key tenets:
  • Have solid downside protection in place
  • Be proactive in booking profits when they are available
  • Look for opportunities to exploit the bear market (profit from it, not just defend against it)
  • Look for signs that the next bull market is nearing
  • Let’s focus on that last one for a moment. Here is Isbitts, talking about a bull market, a couple of hundred words after he announced its a bear market. Am I speaking out of both sides of my mouth?No, I am not. You see, an investor should never be in full-on bull or bear mode. That is a risk in itself. Because despite what many over-confident investors and financial advisorsare thinking now, there is always a risk of being wrong.Beyond that, bear markets tend to move faster than bull markets. The one in 2000 lasted 36 months. The Financial Crisis starting in 2007 lasted 18 months. If we follow that pattern, perhaps this one is less than a year in duration. Who knows? All I know is that portfolio management is a continuous process, and opportunities come up all of the time. They just may not look like the ones we have seen the past several years.Now that the process has been set in motion by the Fed’s action, I will certainly be spending more time in this space analyzing it for you. Stay tuned.Related: S&P 500 Or Dow: Which Is Better?