What would you say you do here?

What would you say you do here?

| April 30, 2022

After yesterday's market drop... many people have been asking me: "What do you tell your clients when the market drops 1,000 points?". Well... this is exactly what I said...


Market Commentary: April 30, 2022

After yesterday's drop, I’m sure you were expecting this email and here it is :-)

It is, of course, never fun watching the Dow drop about 1,000 points. I’ve been doing this for over a ¼ century and can tell you that a 1,000-point drop is rare. However, I will say (as I often do) that we should not look at the point drop. Instead… we should look at the percentage drop. In the case of the Dow, it was down yesterday about 2.8% -- that is far from rare. That fact still does not make it fun to watch, but, it is important to keep that in mind as we process this and determine what we should be doing with portfolios.

Also worth highlighting is that fact that many professional investors (myself included) increasingly find the Dow less and less relevant as a broad market indicator. For example, yesterday we saw the S&P down 3.6% and the tech-heavy NASDAQ down 4.5%. Again, not fun to watch but, again, not uncommon. What is less common is the decoupling between indices. Specifically, the NASDAQ was down more than the S&P and Dow. This tells us that “growth” oriented stocks are faring worse than “value”. We have been tracking that trend for a while and have been updating allocations and recommendations accordingly. [Side note: This decoupling is due to interest rates trending higher. I’ll be talking about that during our next “Second Tuesdays @ 6 With Sovereign" – May 10th].

With all this said… one day drops are great for making the lead on the evening news. However, a measure that I find more meaningful is the % decrease from all-time highs – that is what generally drives our decisions on portfolio allocations and rebalancing. Here’s where those stand for the two broad indices we are currently watch most closely:

  • S&P: Down about 15% from all-time highs
  • NASDAQ: Down about 23% from all-time high

So… what should we do?

Strategically: We should continue to follow the advice of Sir Jack Bogle (the founder of Vanguard): “Don’t just do something… stand there”. In other words… if there are no changes to your cash flow needs or risk tolerances since our last review, then there is nothing significant that should be done to how your investments are deployed.

Tactically: There will likely be a bunch we will do soon tactically. As you know from previous discussions and emails… we look at asset allocations in two ways: Micro and Macro. As a refresher:

  • Micro: This would be a set of trades to “rebalance” a portfolio back to the most recent asset allocation that has been set and fixed for the portfolio. For example… let’s say that it was determined that the asset allocation for a portfolio should be fixed at 70% Equity and 30% Fixed Income. Then… the market sold off and brought the allocation to 60% Equity and 40% Fixed Income. A “Micro” rebalance would simply sell Fixed Income and buy Equity to get the portfolio back into a 70 / 30 mix.
  • Macro: In contrast… a “Macro” reallocation would mean changing the target allocation for a non-fixed portfolio. Using the example above… let’s say that a portfolio had an assigned target of 70% Equity and 30% Fixed Income. Then… the market sold off enough… we would consider changing the actual target allocation – perhaps up to 85% Equity and 15% Fixed Income. We would do this if:
    • The portfolio had a designated “Time Horizon” long enough to justify the increased risk associated with the increase in equity exposure.
    • The market has sold off enough to warrant this type of move. In other words, we would want to see enough of a “sale on stocks” to make us want to get this much more aggressive.

With the current sell off level… we are considering a micro rebalancing. If we see the S&P continue toward a 20% corrected level we will then likely consider a macro re-allocation for any portfolio that is being managed specifically with a “10 Year Plus Time Horizon”. If the sell off continued to a 30% corrected level, we would then consider a macro reallocation for our portfolios with a “6 – 10 Year Time Horizon”. To be sure, depending on other factors, we may even consider doing the re-allocation sooner or later than 20% - 30%, but 20% - 30% is definitely a target we generally like for macro re-allocations. 

This is part art and part science. 

There is no way to know with certainty when, exactly, is the right time to pull the trigger on a macro reallocation. If we’re too hasty, we may reallocate too early. If we’re too patient, we may miss the opportunity. Regardless, the fact is that you are fully invested at this very moment in an allocation that we feel makes sense for your cash flow needs / time horizon / risk tolerance. So, if we hit the reallocation to early, too late, or, not at all, it will not have a meaningful impact on your portfolio and plan strategically over the long term. However, we will try to find a good time to make a tactical move that can enhance your long-term risk / return outcome.

Lastly, as always, if anything has changed on “your side of the table” (cash flow needs, risk tolerance, etc.) please let us know asap. For now, please know that we will continue to monitor and take action opportunistically if we feel the risk / return is worth it.

All my best,