Dear Mr. Market:
Since 1950 you (the market) have risen an average of +1.4% over the last five trading days of the year. We typically see some tax loss selling in the early part of the month and then a positive finish to the year. Over the past 45 years, 34 of them have helped make this seasonal phenomenon seem real but this year is looking like Santa will bring a massive lump of coal instead of a rally.
While most Decembers in general are positive, this one so far has literally been the worst since 1931. It actually goes beyond just a bad month that is normally positive; as you can see from the graphic we put together below this market has been struggling for the entire fourth quarter.
Large Caps, as measured by the S&P 500, are very close to touching bear market levels. Whether we need to officially hit the -20% (official bear market definition) or not shouldn’t matter; it’s flat out dismal out there. Notice how both Small and Mid Caps have already reached bear market levels. Even though bonds have not had a great year they have at least mitigated some damage for those who have exposure to the asset class.
All that said, there has been very few places to hide and the fear levels are mounting. If you don’t have any alternatives or bond exposure in your portfolio you are basically at the will of the market and will have to either throw in the towel or ride it out. Those that do have an allocation with exposure to other asset classes outside of stocks have options.
We recently wrote a rough sketch on how we would approach portfolios if this indeed turned into a bear market. Many investors will fold up and do the worst thing you can do; sell and cement losses with no strategy aside from quitting. Our goal is not to “throw good money after bad” and keep buying into a market that is getting slaughtered but rather tactically take advantage of asset classes that are more resilient than equities.
Going back to our grid above…let us ask you a question:
What should you buy and what should you sell?
Our short answer is that we will gradually sell some alternative assets (not listed in the above grid but mentioned in this blog many times) and about 5% of our bond exposure. From there we plan to first nibble at Small Caps and the Mid Caps as those have been hit the hardest the past three months.
We’ll update our readers and clients more later but just because Santa didn’t delivery a rally this year doesn’t mean the stock market is broken forever; it’s merely giving you an opportunity to do something different than you did last time.