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Yesterday the S&P 500 broke below its 200-day moving average for the first time since October 2023 (a moment that marked an incredible buying opportunity, I should mention). That being said, this time feels different. While stocks rallied somewhat yesterday to close above, today we ripped right through to the downside as though there wasn’t a shred of support in sight. Today’s close below, should it happen, would be the first one in some 334 trading days. But maybe we’ll bounce. I don’t know.

Assume a convincing break below this long-term moving average and what it might mean for your own investments in the stock market.

What do you do now?

This is the obvious question on everyone’s minds.

My answer today is that the time to plan for these things is not in the midst of them happening. A strategy for how your portfolio will survive and capitalize on drawdowns is something that should be created in peacetime, not in the throes of the panic du jour. Having no plan whatsoever and then coming up with one as emotions run high is a recipe for disaster.

Some ideas

There are a million things investors (and their advisors) could choose to prepare for these moments. Here are a few:

1. I will sell when I get nervous. This is probably the worst plan you could come up with. There are reasons to be nervous at all times, we just feel them more acutely when prices fall and volatility ramps. You will not be able to buy back in because the sort of things that will be happening at lower levels will make you even more nervous, not less. “I’ll sell the dip but then buy the crash” is an emotional Grail Quest. You will fail every time. Barry and I were still talking to people who got out before the 2008 crash and stayed in cash throughout 2009, 2010, 2011, 2012. Thousands of people. You wouldn’t believe it. Or maybe you would. What good is getting out if you’re paralyzed for the recovery?

2. I will get out and wait for the dust to settle. The dust never settles. You will be buying back in much higher - or possibly never - if you’re looking for the all clear sign. It just will not come.

3. I will sell when the stock market breaks below the 200-day moving average or falls more than 10%. Okay, sell what? Everything? Half? What about the whipsaws? What happens when the market crosses below, above, below and above again inside of a month? Are you consistently trading all of these moments? Intra-day prices count or just 4 o’clock? Closing weekly price on Fridays? What’s the buy-in rule? Subjective?

4. I’ll wait for the economy to improve. The economy according to whom? Which data points? GDP growth? Unemployment? Corporate earnings? Inflation? Consumer Confidence? No one can do this. It’s nonsense on stilts. My inbox is filled with thousands of “notes” about the state of the economy every month. In the meanwhile, we’ve been in recession just 2 months out of the last 15 years (April and May 2020) and during the entirety of the rest of that 15 year period we’ve been in an economic expansion of varying levels of strength. When the economy is at its very worst, the very best buying opportunities are presenting themselves. It will literally never feel that way in the moment. And waiting for these moments creates a huge opportunity cost.

5. I will employ a rules-based tactical strategy to limit my downside. Okay, we do this. I wrote about it last week. How will you operate yours? What are the rules? Are they relevant to the speed of today’s market or backtested based on the 1970’s or the 1990’s? Can you stick with the rules? Who is setting them? Who is enforcing them? How are the trades being executed? What securities are in your risk-on and risk-off baskets? What is the drag being created from churn? How much are you paying in fees or trading costs for this tactical activity? How does the tactical strategy fit into your overall asset allocation? When do you decide about the proportion of tactical vs long-term asset allocation? How are you reaching these decisions? What is the process by which you’re making them? When do you break the rules and how will you know when it’s time to?

6. I will hedge with options. Sure, no problem. Who is handling these trades? What are they costing you? How much are you capping the potential upside in your efforts to limit your downside? Are you okay with that trade-off? Will limiting the volatility of your portfolio in the short-run end up limiting your future gains in the long-term? Is continuously rolling options contracts a worthwhile use of your time and mental energy?

7. I will allocate to the best global macro hedge fund manager I can access and outsource the risk management to them. Jesus Christ.

8. I will reduce my long-term equity allocation and take less risk to begin with. Okay, that’s rational. Just don’t expect to be happy with this decision many years from now. You won’t be. It’s a temporary solution that will make the coming years feel easier and the coming decades feel excruciating.

9. I will diversify, stay put and hope for the best. I like this. It can work. But it’s up to you. Not everyone can watch a diversified portfolio like a 60/40 stock/bond mix decline 18% in a calendar year and resist the urge to do nothing. We just lived through one such calendar year in 2022. How’d you do? What if 2022’s conditions had gone on for twice as long? Two years? Three years? It’s important to picture a scenario like this because, sooner or later, it will happen.

10. I will follow the news and use my gut instinct to make buy and sell decisions. This is partly rational but unlikely to work for long. You will eventually come back to one of the options above when this fails. Unless you are one of the greatest market timers of all time, there will be substantial missed opportunities or drawdowns along the way. Will that make you bitter? Will it make you think the market is out to get you when you zig while the crowd zags? Will you seek revenge with your trades or pray for stock market karma? It will not come. There are no rewards for trying hard and no extra returns for effort. Believe me, it doesn’t work this way.

I don’t know which of these is the right answer for you, but these are the right questions to be thinking about.

Tom Lee to the Rescue

We’re very fortunate to have people like Tom Lee in our orbit and when the moment demands it, we bring these people and their insights directly into your life. Tom has been on the right side of the market for a long time and has not backed away from his secular bull market view regardless of some of the most perilous moments we’ve experienced over the years.

Without any further adieu, I present to you the newest episode of The Compound and Friends, featuring our friend Tom Lee.

YouTube:

Podcast audio:

I hope you enjoy it. Have a great weekend, we’ll be back with you this coming week - as always! - JB

If you want to talk about your portfolio or financial plan, Certified Financial Planners are standing by. Go here.