WASHINGTON. As we discussed in our previous column, last Friday’s market massacre was a significant cross-sector disaster. Bank stocks were hammered the worst. But numerous other sectors, from Healthcare to Consumer Discretionary and Consumer Durable stocks got whacked along with them. Energy stocks joined the rout. And pretty soon the only safe place seemed to be bonds, baby bonds, quality preferred stocks and, of course, cash. So does a Fed led recession lurk just around the corner? If so, what can we do to bulletproof our investment portfolios?
Given the Fed’s interest rate overreach, a recession beginning later this year is certainly possible. So it’s probably time for us to pull in our bullish investment horns a bit. Then we can examine what we can do to hold on to our better investments while hunkering down for a negative market environment. The right defensive moves should help us preserve the remainder of this spring’s significant market rally in our portfolios. But even if we’re wrong, we can begin to buy back in to stocks we once liked as they might recover quickly from last week’s beating.
As we adjust, we’ll also need to remember one key item. When stocks get hit this hard and this deeply on a single day, the selling usually continues, more or less, for the next 2-3 days to 2-3 weeks. After that point, the sellers get exhausted, stocks stop going down. Then they tend to resume their rise. But tentatively. That’s because investors still fear a downward surprise. And they have good reason to fear an upcoming Fed led recession, even though that was never the intention of the nation’s central bankers.
Interest rates in 2019: A Fed led recession ahead?
Part of Wall Street’s late week rout was due to the calamitous collapse in bank and financial stocks that set in after the Fed’s Wednesday pronouncements sank in. That’s because increasing interest rates allow banks to widen the interest rate spread in their various loan portfolios, thus increasing profits handsomely. But anticipating lower rates for a longer period of time clobbered the bank stocks in mid-rally. With lower rates, reason investors, come lower profits. So let’s exit these stocks.
And they did. Big time. Financials led the substantial retreat we’re currently calling the Bloody Friday massacre.
2019 10-year Treasury yields will likely trade now in a range somewhere between 2.25 percent to 2.75 percent, at least until some sign of inflation actually appears. Which, given the Fed’s interest rate overkill, is not likely to happen anytime soon. Which is why bankers and holders of bank and financial stocks very much fear a Fed led recession.
A Slowing World Economy
Given that the Chinese economy is currently stuck in a quicksand of that country’s own making, and that the Eurozone is still in the midst of becoming a new Islamic Caliphate as its socialistic economies grind to a self-induced halt, we see an all-too-predictable risk of DEflationas a very real possibility. Which is what you get when only wealthy elites and corporate masters can gain access to capital – not individual investors and consumers.
What are we doing to shore up our portfolios?
As we’ve already noted, during last week’s Bloody Friday massacre of stocks, we immediately sold off marginal stocks in our portfolio that were not behaving robustly. All we need now is to endure a back-to-back pairing of Bloody Monday and Tuesday market massacres. That tends to change the market tone. Fast.
Despite wishing to have a certain percentage of foreign stocks in our balanced portfolio, we’ve now cut most of them. Europe cannot grow, China is stuck for the indefinite future (except, perhaps, for Chines tech) and much of the rest of the world is run by kleptocrats. So we’re largely confining remaining investments to the US.
Having decreased our conservative holdings in baby bonds and preferred stocks, we’ll increase those holding once again, tossing in a few high-grade utilities, like Excelon (trading symbol: EXC) for good measure. If we end up in recession, markets will start to feel the effects roughly 6 months in advance. Last Friday may or may not have been our signal. But it could take one or more weeks for us to conclude this.
In our interest-centric holdings, we’re already kicking up the credit quality of our current holdings. Weaker companies can run into problems paying preferred stock dividends and baby bond interest. So perhaps it’s time to sacrifice a bit of yield, and trade the volatile investments out in favor of investments whose companies have more reliable credit ratings.
Since we no longer seem at risk for ever-increasing interest rates, longer term baby bonds and preferred stocks may become more desirable investments than the shorter maturities we currently hold.
What’s next with Mr Market?
Fingers crossed for the week ahead. If anything, last Friday’s nasty downward move showed us there’s always a risk surprise lurking in every bullish corner. Including an eventual recession.
A quick look at the unmodified McClellan Oscillator chart below, which measures “overbought” and “oversold” markets, shows we’ve dropped into moderately oversold territory (below the zero x axis of the chart). About twice that move downward should get us to extreme oversold territory. At that point, we often (but not always) get a sharp upward bounce from Mr Market. Which, if you’re a pure chartist, might just be the time to bail out of some of our crazier holdings.
We may also employ another pair of our usual weapons if conditions worsen: the regular short S&P 500 ETF (SH), or the more volatile double-short S&P 500 ETF (SDS) to cover our remaining investments. We’ll let you know if we do.
– Headline image: Cartoon by Ben Garrison, via grrgraphics.com.
Reproduced with permission and by arrangement with grrgraphics.