Sept. 3, 2019
Is this the eye of the hurricane?
The stock market is fluttering near all-time highs but has gone nowhere for 19 months. The bond market is pushing government bond yields toward or below zero. Gold is surging. The Fed is cutting. Tweets are flying. Oh, and there’s a major hurricane bearing down on the east coast of the US. So, I can’t help but make the analogy between the shifting winds and intermittent rain squalls of the financial markets, and those of Hurricane Dorian as it approaches the United States.
I grew up in New Jersey, where hurricanes do not land often. However, I have lived in South Florida for the past 22 years. Like all of us here, that means understanding what hurricanes are. We also learn the basics of how they work. You can’t help it, what with the wall-to-wall news coverage that accompanies a big storm.
The eye has it
Those less familiar with tropical weather patterns have still heard the phrase “eye of the hurricane.” The eye is really two things in one. That is, the part spinning in circles at the fastest rate, right at the center of the storm, is the “eye.” That part of the storm often does the most severe damage.
This is why there is so much media attention on where the eye makes landfall, and which areas it passes through. The eye is really like the hole in the hurricane doughnut.
You can clearly see the eye of the hurricane in this picture. Think of the left side of the photo as 2018, and consider that we are somewhere inside the eye now. Some wind, some rain, but not a catastrophe for your portfolio right now.
There is another, very important part of the eye. There, the wind does not blow much. It is calm and sunny. When it passes through, it is like there is no storm at all. But you also know that the other part of the storm is coming behind it.
And THAT is what may be developing right now in the financial markets. You see, there are 3 major sections of a hurricane:
- The front side of the storm (typically on the left when they come to Florida since they travel east to west. In other words, to the left of the eye)
- The eye
- The backside of the storm (typically on the right, after the eye)
There is a lot going on in the markets, especially for Labor Day weekend. This follows a period of relative calmness earlier in 2019. And that calm followed a very stormy fourth quarter. The more I look at things from my very multi-angled view of global financial conditions, the more I see similarities between this current climate and that of a hurricane.
Tracking the storm
The winds of the storm date back to late January 2018. That is when the stock market’s massive post-election move stalled. As noted above, t he S&P 500 has really not moved much since then. However, a few other market areas have moved over the past 19 months. And, they tell an increasingly stormy story that all investors should be prepared for.
To me, these are signs of an investment market climate that feels like the eye of the hurricane. That is, the sunny part after the storm has begun. But as with Dorian, Irma, Sandy, and other recent major storms, there is another side to the storm. We just don’t know when the wind will go from occasional to constant, and when the rains will turn from bands to a washout.
Successful retirement investing is a constant, relentless assessment of potential rewards versus the potential for risk of major loss. Sure, we can just hope the eventual storm passes. And maybe it will. But why take that risk, when you can do some basic things to prepare. For storms, we take in the patio furniture, make sure we have food in our pantry and gas in our cars, just in case the neighborhood has some recovering to do when it’s over.
But if you are nearing retirement, or recently retired, you don’t have the luxury of waiting around to see what happens. Your home may not be impacted by a market storm, but your retirement portfolio certainly could be. How do you prepare for that? Here is my shortlist of answers:
Don’t try to simply pick one scenario and plan for that alone. I see too many investors boil everything down to a “market call.” Better to think of investing as a trade-off between reward potential and potential for major risk. What is “major?” Everyone’s answer is different. Essentially, it depends on how sturdy your portfolio “house” was before the storm arrived.
Prioritize preservation of capital…even if that is not your usual priority.
We are likely toward the tail end of a long and prosperous economic cycle. So, whatever you would consider being a “relatively conservative” positioning in your portfolio, consider being there now. For a more aggressive investor, it might mean you still hold a large allocation to stocks. But perhaps it will be a bit shy of your normal position. I have recently shared some specific ways you can aim to preserve capital. In the coming days and weeks, I will share more.
Remember what you are truly investing for
Your objectives should outweigh any efforts to guess which way the stock, bond, commodity and currency markets will be impacted by the changing winds. This is particularly true for those within 10 years either side of retirement. Gee, it would really be nice to be in full “risk-on” mode if we wake up one morning and the trade war is over, and the markets rally for weeks. But weigh how that would impact you financially and emotionally, versus the opposite occurring.
Recognize that the storm will pass
When it does, you will want to have as little cleanup to do as possible. That comes from not waiting until the last minute to make your preparations. Furthermore, you want to start thinking now about what actions you may take on the other side of the market storm. For instance, maybe there are stocks or market segments you have had on your wish list for years but have held back from buying. Your opportunity could pop up very quickly. After all, as with hurricanes, market storms move through at different speeds.
Understand what you own
Most portfolios over which we conduct third-party reviews have a combination of common issues that represent hidden risks. And it not so much about costs, like expense ratios on funds and such. More often, it is a portfolio constructed as if the investment environment will never change. They are static, not adaptable. That is usually a signal that the investor (and, if they are being guided by a professional, the advisor) has not really taken a 360-degree view of inherent risk. After 10 years of market bliss, this is natural. But it is not advisable.
I am not a bull or a bear, I am a realist and a devout risk-manager. We have had 10 years of a massive debt buildup by consumers, corporations, and governments. During that time, stock and bond prices have risen relentlessly. For over 2 years, I have been showing you different pieces of evidence that risk was starting to rise and reward potential starting to shrink. As the figures in the chart above show, that has been happening steadily, though silently, for 19 months.
So, there is a heightened risk that investor confidence breaks. And, as December’s market crash-test reminded us, wealth is lost far more quickly than it is gained.
Respect the laws of gravity. And put up your investment hurricane shutters . And for Pete’s sake, take the patio furniture in before the storm gets too close!
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