Cash is king and stocks are on sale

The stock market certainly feels like a rollercoaster these days. We had a strong finish in 2021, but almost everything went downhill from there, except for oil and inflation

It has been a while since I wrote a mid-year market outlook. But after a disappointing first half of the year, I thought it might be an excellent opportunity to throw a few charts and give you a perspective of where we are.

The S&P 500 is in the bear market territory, down 20% for the year. Growth investors have taken a bigger hit, down -28%, while value investors had more modest losses at -12%. US Aggregate Bond is down: -11%, Bitcoin: lost -57%, while Cash: earned a modest 0.1%.

The US is a dominant force.

If you read my newsletter regularly, you know that I was optimistic about the US economy at the beginning of the year. After all, the US has one of the best managed and globally recognized companies and brands.

Let me give you a perspective of the US footprint on the world economy:

• An estimated 1 billion people worldwide have an iPhone.
• 1.4 billion monthly active devices running Windows 10 or Windows 11
• 3 billion people use Facebook
• 1.9 billion Coca-Cola drinks are served every day
• 157 million visitors to all Disney parks every year
• Netflix has 221 million subscribers
• Amazon ships approximately 1.6 million packages a day, or 18.5 orders per second
• Google processes over 8.5 billion searches per day
• P&G’s nearly 300 brands are sold in more than 160 countries.
• Visa handles an average of 150 million transactions per day

Everyone has a plan till they get punched in the face

When a reporter asked Mike Tyson whether he was worried about Evander Holyfield and his fight plan, he made his famous quote; “Everyone has a plan until they get punched in the face.”
That’s how 2022 feels to me. If you feel the same way, you are not alone.

My investment philosophy is to invest in high-quality US companies with outstanding leadership, a fortress balance sheet, a wide MOAT, and a consistent ability to generate cash. Companies can constantly maneuver between GAAP and NON-GAAP earnings, but cash is always cash.   I expected that 2022 would be volatile, but only hindsight can predict how low the market will go. The plan was to ride the market volatility until we got more positive news towards the year’s second half.

And here we are. 2022 has been one of the most treacherous years for both investing and trading since the Global Financial Crisis in 2008-2009. The negative news on a daily basis can be overwhelming and confusing even for experienced investors.

Let’s summarize what happened in the first half of 2022: 

• We experienced the third bear market in the span of 5 years – Oct-Dec 2018, Feb – Mar 2020, and now
• The S&P 500 posted its worst first half-year performance since 1970
• We marked the worst bond performance in the history of the markets
• The Fed appeared awfully late and reactive in their monetary policy decisions.
• Inflation measured by the Consumer price index went up 8.6% by May 2022. The highest rate since the early 1980s.
• Russia has attacked Ukraine. The first European country to attack another European country since WWII. The two countries combined are one of the largest global exporters of wheat, fertilizers, oil, and natural gas.
• The EU, the UK, and the US have imposed stiff economic sanctions on Russia to limit their export revenue, adding more fuel to the inflation fire.

• China has enforced strict zero covid policies and lockdowns in many metropolitan areas.
• US mortgage rates have jumped to nearly 6%
• Oil is over $6 at the pump here in California
• The price of electricity has nearly doubled in the European Union
• Corporate earnings are expected to decline, but it remains to be seen how far and how deep
• The average price of a new home in the US is now over 10x higher than per capita disposable income, the highest ratio in history.
• Consumer sentiment dropped to the lowest level since the Global Financial Crisis
• Many major retailers reported a sharp increase in inventory

Cash is king?

2022 has been a great year to keep your cash on the sideline, especially if you are a stock or a bond investor. With a return of 0.1%, cash has been one of the best performing asset classes besides oil and natural gas. But before I get you too excited about hoarding cash, look at the 15%-year performance of stock, bonds, and cash.

Since 2007, cash (savings or money market account) achieved a total return of 9% versus 230% for the S&P 500 and 55% for bonds. Besides that, the cumulative inflation was 41% for the same period. In other words, holding cash would have reduced your purchasing power by a third in 15 years.

I would recommend splitting your cash into three buckets. The first bucket is your emergency fund. Keep at least 6 to 12 months of living expenses in this bucket. That is your rainy-day money

The second bucket is money that you will need in a short period of time – buy or remodel your home, get a new car, cover medical bills, etc. While tempting to invest this portion of your money when the market is going up, you should keep them relatively safe in your savings accounts or bonds.

The third bucket is the extra cash you can invest long-term. This bucket contains money you don’t need to touch for at least 5 to 10 years. That is most likely your 401k, Roth IRA, or an investment account with a long-term investment horizon.

Stocks are on sale

Here is a list of some of the worst performers in 2022 in the S&P 500. I am sure you recognize many blue-chip names like Netflix, Nvidia, AMD, Amazon, Adobe, Booking, Microsoft, and Apple. Thermo Fisher, Regeneron, and more. You also need to note that these are some of the companies with the best performance on a 10-, 15- and 20- year basis.

Focus on your goals

2008 was one of the worst years in recent history. Thousands of people lost their homes and jobs. The stock market crashed by 50%. Several banks disappeared overnight. We worked in fear that each day was our last day on the job. It was the dark period to be on Wall Street. Yet, I ran my first marathon in November 2008. I turned a trashy year into personal success. I don’t remember my 401k balance in 2008, but I remember crossing the finish line, getting a medal, and inhaling a bottle of Gatorade.

Today, my advice for you is to focus on yourself and how to achieve your goals. Ignore the negative news and continue working on your plan.

This, too, shall pass. 

I have two young children – a 4-year-old boy and a 1-year-old girl. You can imagine there is a lot of energy at home. So every time one of my kids pours milk on the floor, breaks a glass, or makes a mess, I try to take a deep breath and ask myself, will that matter in a year or ten years from now. In most cases, the answer is no. It won’t.

If the stock market aggravates you today, ask yourself if that matters to you in a year or ten years. Most likely, today will look like a tiny blip on a long-term chart. This bear market is a true test of your risk tolerance and emotional ability to accept market volatility. It’s easy to take a risk when the stocks have only gone up for 13 years. A generation of investors has not experienced an actual bear market and inflation without having the back of the Fed. There is a new sheriff in town. The show will go on, but the players might be different.

Sparks of hope

While we are not out of the woods yet, there are signs of hope that inflation is peaking.
•    Core PCE Price Index (excluding Food & Energy) has declined for three consecutive months, moving from a high of 5.3% down to 4.7%.
•    The price of WTI oil has dropped under $100 at the time of this article
•    Natural gas prices dropped from $9 to $5.7
•    Other commodities such as corn, wheat, soybeans, cotton, and copper are all down over 20% – 30% from their recent highs
•    Consumer spending remains stable, and the saving rate is on a slight upward trend
•    The unemployment rate remains low, and the number of open positions exceeds the number of people looking for work

The game plan

Bear markets are normal. They are not pleasant, but they are an ordinary part of the economic cycle. Did you know that since 1929 the S&P 500 has posted declines in 46% of the days the markets were open? If you check your investments daily, your portfolio will appear very volatile. You will observe almost as many green days as red days. In contrast, the probability of seeing losses over ten years is only 6%.

Two landmark studies from behavioral economists Shlomo Benartzi and Richard Thaler found that the more often we check our portfolio, the lower our long-term returns are likely to be. They found that investors with long-term goals who resisted the temptation to monitor the market earned significantly higher profits over time than those who checked annually. For the average person, the pain of losing is greater than the pleasure of making gains. This phenomenon worsens when you constantly check day to day movements of your portfolio and lose sight of your long-term goals. Mr. Thaler and Mr. Benartzi call this “myopic loss aversion.”

So we are in the middle of a market storm, and here are the steps that you need to follow.

• Stay the course and follow your goals.
• If you are already invested, stay invested. There is no benefit to trying to time the market.
• Dollar-cost averaging your long-term cash. Holding more cash than you need will reduce your long-term purchasing power.
• Clean up your portfolio from any stocks and funds that keep you from sleeping well at night
• Rebalance your portfolio according to your risk tolerance and investment horizon.
• Focus on the long-term and ignore short-term news.

Famous last words

“Buy when there’s blood in the streets, even if the blood is your own.” Nathan Rothschild. a 19th-century British financier and member of the Rothschild banking family, made a fortune buying in the panic that followed the Battle of Waterloo against Napoleon. The Rothschild family had established its own network of couriers, which informed them about the Napoleon defeat before the news reached the British society. 

Bear markets can be long and gut-wrenching. Any positive news gets crushed in a swarm of negativity. Your portfolio gets whiplashed every day. It’s easy to get distracted from following your goals.

Fortunately, this bear market will eventually end. The stock market is a leading indicator. It frequently reaches the bottom before the economy is fully recovered. However, those bottoms are tough to identify because they coincide with a lot of negative economic news, which can be driven by a range of lagging indicators such as CPI, unemployment, corporate earnings, and GDP readings. Timing the market bottom takes a lot of stamina and courage, as often it’s the opposite of what your gut is telling you.

Today offers a great opportunity to reflect on yourself and your financial goals. Review your priorities and determine your path. Let the stock market do the heavy lifting. So you can focus on the things that are in your control.