I don't like to talk about stock market crashes all the time, but I think it's important for everyone to understand the macroeconomic environment in which they're investing. Yes, company fundamentals are more important in the long-term. But, let's face... does anyone really want to lose their hard earned money in the short- and medium- terms? I surely don't.
As a full-time investor, I don't have the tolerance to be down a huge amount in my portfolio. I am hedged with several asset classes, but my highest risk position is long-only public equities — which is what I mostly share. So, I try to stick to Warren Buffet's rules of investing.
"Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1." – Warren Buffet
So, let's face it... a stock market crash or correction is due. There's no arguing "if"... it's only debatable "when".
I hate to break it to the self-proclaimed apes... but this meme market isn't going to last forever.
The catalyst for what's going to shift sentiment is also debatable, since no knows... and typically it's what no one expects. But, based on the unprecedented liquidity in the market, my guess will be the tapering signal from the Fed. Note: my use of the key word signal.
Since the pandemic started in March 2020, the U.S. Federal Reserve (i.e. the Fed) cut the funds rate to the range of 0-0.25%; but they also began purchasing $120bn of bonds per month for additional stimulus to the economy. The asset purchases are known as quantitative easing (QE) – which increases the money supply and liquidity, which in turn stimulates the economy.
What exactly does this "money printing" do?
- Lowers borrowing costs – for spending or investing
- Put downward pressure on long-term yields to boost investment
- Directly supports the lowering of interest rates for residential and commercial mortgages. $40bn mortgage-backed securities (MBS) – of the $120bn – is purchased monthly.
- Ensures the functioning of the financial markets
Once the Fed stops (i.e. tapers) supporting the markets and the economy with its liquidity, what do you think will happen? We'll have downwards pressure on asset prices, including equities. But, guess what? The expectation of it will be enough to scare people away. The expectation of it, will be when Jay Powell "signals" tapering ahead – which he promised to do, several times.
There have been several members of the Fed who suggested the tapering conversation should begin. Powell, in the last Fed meeting in July acknowledged that progress was being made on taper conditions, though there's still a ways to go.
“We’re making progress. We expect further progress and if things go well we will reach that goal,” said Jerome Powell (on tapering).
Their next meeting of The Federal Open Market Committee (FOMC) is Sept. 21-22nd. I expect them to "signal" then... or on their November 2nd-3rd gathering at the latest.
So, yeah... I'm expecting a correction in the markets in the next couple months.
The Signals Before the Signaling
There are three data points to watch prior to the Fed signaling the start of tapering – inflation, unemployment, and COVID-19 numbers. I'll give you my thoughts on each of these.
Although the Fed uses personal consumption expenditures price index (PCE) for measuring inflation, we can measure inflation using the more broadly looked at consumer price index (CPI). Last month's data was aligned with expectations, and we can see that inflation is, in fact, cooling off and appears to be more transitory. Most inflation is in areas of Energy and other items like used cars, appliances, etc. – which I believe are mostly due to temporary supply constraints. This means that the Fed appears to be right in their thesis of transitory inflation, which is a sign that the bond purchases are still justified. This type of data, although not supportive of a recovering (or overheating) economy, will continue helping Tech & growth stocks in the short-term.
The Producer Price Index (PPI) – which measures prices paid by domestic (commercial) producers for their output – however, read a different story. This is essentially a leading indicator for the CPI. This came in a bit hotter than expected at 1% MoM increase, where expectation was 0.6%. This tells us that inflation might be sticker than the Fed thinks; in which case it would need to consider tapering sooner than expected. This puts downwards pressure on stocks, as we just discussed.
Unemployment data seems to be coming in strong as well; which suggests the Fed may start signaling the tapering soon. We are now at 5.4% unemployment, while their long-term target is 4%. We should be there by next year, for sure.
COVID-19 Delta Variant
Let me start by saying, I am no health expert. But, unfortunately, during these times everyone is forced to be one in order to determine their own thesis on COVID-19. Whether it be for investments or social life or just your mental sanity, everyone (rightfully so) has an opinion. So, here's mine.
Based on the data, I don't perceive the Delta variant as a huge threat as it is played out to be right now.
Cases are increasing rapidly in the US, and about 50% off the peak of the largest (second) wave in January 2021. But, death rates are 18% off the peak. This means, less people are dying. About 50% of the US population is vaccinated, which is helping reduce the hospitalization and severe symptoms.
We know the Delta variant is 40-60% more contagious than the Alpha variant, but its still questionable whether it is more dangerous. However, it's very clear that the unvaccinated are more vulnerable. With 60% of the population having at least one dose, I feel confident that we can keep the death rates low and move the economy forward – or maybe that's just my hope.
I personally feel that Delta variant fears are a true buying opportunity, if they present themselves.
How Should I Position My Portfolio?
I can't tell you what to do , but I can only tell you how I'm positioning my portfolio, given my opinions above. My biggest assumption is that The Fed will signal tapering by the end of the year, and I am expecting a market pullback when that happens.
I am mostly a technology investor, because it's what I love, believe in, and understand. However, I do love traditional value plays in consumer defensive (and cyclical) sectors. I will continue to hold and buy those opportunistically between now and the year-end.
I know there is a lot of chasing of cyclical stocks, like financials and energy, in anticipation of higher inflation and rates. Yes, they could definitely and will likely be short-term winners. But, I honestly don't like owning those companies; and I'm just not interested in trading. But, I can understand why someone would do that. I enjoy having a lifestyle where I don't need to be plugged in 24/7 (though that happens anyway). So, how am I playing this?
I'm keeping 30% of my long-only equities portfolio in index funds to get a more balanced exposure. I know there will be a lot of volatility between the value-growth plays in the short-term, and I am just not interested in chasing it. I like to own companies and hold them for the long-term.
So, that's what I'll be doing. You don't have to do the same, but it's a strategy that I am fully comfortable with. I am keeping cash on the sidelines (a lot of it) to buy in September, or whenever the opportunity arises. Whether the catalyst is The Fed or Delta... I'll be ready :)
I'm creating a watchlist of stocks and analyzing the companies, which I am sharing on my newsletter and YouTube; so, make you're subscribed!
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