The new year gave the financial markets some nice upward momentum – until it didn’t. In January, enough stock market indicators were turning positive to have commentators suggesting the bear market was over, but that dynamic has turned around 180 degrees. The late Marty Zweig had a saying: “There is nothing so bearish as a failed bullish signal” and this time his quote is ringing true.
We have seen market action like this several times over the past 15 months and it underscores the need for agile, pro-active management of investments rather than passive index investing that had been the rage for a while.
The most current market weakness is caused by a spate of bank failures. Rising interest rates caused large losses in bond portfolios, bringing down the 16th largest bank in the country. Silicon Valley Bank (SVB) was not all that important to the banking industry until it collapsed. Its failure started a flurry of bank failures culminating (so far) with Credit Suisse being forced into a shotgun marriage with United Bank of Switzerland (UBS).
The Fed’s tendency in these monetary tightening cycles is to raise rates until things break in the economy. Breaking banks count. We had zero bank failures in 2021 and 2022, so the current events are significant. The problem with the Fed’s approach is that there is a long lag time, as much as a year, between interest rate hikes and their effect on the economy. The Fed could have stopped raising rates last week and we still wouldn’t see whether rate hikes were having the desired effect for about a year. As a result of this, I expect to see more failed banks, and perhaps insurance companies, too, so we are not out of the woods yet.
The reason I bring bank failures up is that there is never just one cockroach. The rising interest rates that are creating bank failures have not changed since SVB went under. In fact, things have gotten worse since Fed just announced another interest rate hike on March 22nd. There are more banks in trouble, we just don’t know which ones or when they might be shut down, for those are the kind of secrets that fortunes are built upon. Bear Stearns failed in March 2008 and the stock market rallied in response – until it didn’t. Six months later, Lehman Brothers failed – and we all remember how 2008 ended. So keep your eye out for more cockroaches.
Both Ryan and I have commented about the “yield curve” over the past year. This refers to the relationship between long-term and short-term interest rates. Normally long-term rates are higher than short-term rates, to pay for the added inflation risk. When this relationship reverses, it is one of the more reliable indicators of a coming economic recession, called an inverted yield curve. For almost a year, short-term interest rates have been higher than long-term rates. Now the inversion is deeper than it has been since the early 1980s. No, I don’t think we are out of the woods, not even close.
One of my duties at Shadowridge is managing the Future Technologies model portfolio. As a result of the outlook for continued market weakness, my focus has shifted from aggressive growth to a more defensive technology portfolio. I’m more interested now in holding stocks of companies with products or services that have proven to be essential; things people simply must have. Over the next year or two, I believe these defensive tech stocks will outperform the smaller unproven companies. At this writing on March 28, 2023, The Future Tech portfolios are 23% in cash and money market funds, with 54% in tech stocks. Hedges (inverse funds that go up when an index goes down) make up the rest of the portfolio, creating an equivalent of only 22% stock market risk.
Hedges allow us to continue to hold our better performing holdings with reduced market risk. This positioning allows us to “stay in the game” and be invested when the bottom of the market cycle is reached. If instead we were to move 100% to cash, the risk of loss might be lower for the moment, but we would likely miss the first days or weeks of a recovery, which are usually the most powerful. Hedging allows us to take a more moderate approach to riding the stock market cycles rather than make all-or-nothing bets.
This ability to Adapt to Changing Markets® is what makes Shadowridge a leader in portfolio management today. Tell your friends and have them call us at 888-434-1427 for a portfolio review.
