Preserving capital is key: markets perch on the precipice of pain

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there is a time to make money and a time not to lose money. Were now in a while not to lose money. A time to focus on preserving your capital when even the pillars of the market begin to crumble. The the market sell-off has turned into a complete sell-off. Even the stalwart safe haven Apple (AAPL) has formed 25% of craters to date.

aapl sa chart

apple chart (Looking for Alpha)

Old-school Wall Street wisdom says that when you see a major market mainstay like Apple start to crumble, we’re on the verge of pain. In fact, we will have definitely entered bear market territory if the S&P 500 drops another 10 points and closes at or below $3,837, which would be exactly 20% below its highs, officially ending the bull market.

sp500

S&P 500 chart (Looking for Alpha)

The hammering in shares of Walmart (WMT) and Target (TGT) as the companies lost profits was a dire sign that consumers are beginning to tighten their belts. Furthermore, the Nasdaq (QQQ) has already firmly entered bear market territory, as it is down 30% year-to-date.

nas chart

NASDAQ Chart (Looking for Alpha)

What is to blame for all this market chaos? I’ve boiled it down to three main factors. In the following sections I will give a brief synopsis of each. Let us begin.

Three major market headwinds

runaway inflation

Inflation is rampant all over the world, but especially in the US. In fact, we are currently at 40-year highs.

cpi rates

CPI rate (tradingeconomics.com)

Inflation is an insidious tax on the general public. It crept up stealthily and grew like a weed before anyone had time to notice. The Fed is immensely behind the curve at this point. Commodity shortages caused by supply chain issues and a high level of demand for goods and services as the pandemic faded are the main culprits. Wage inflation due to low unemployment has also contributed to the sharp rise in inflation, as rising labor costs have also been factored into prices.

Also, although the CPI chart above shows that the inflation rate may have peaked, economists believe it is likely to remain elevated for quite some time. This has caused the Fed to do a dovish to aggressive U-turn, which does not bode well for the markets. This is why.

Federal Reserve Policy Change

The Fed changed its policy in a jiffy once its realized inflation was not “transient” as Chairman Powell assured us many times. However, once he realized they were wrong, he unveiled a plan to tighten financial conditions by raising rates and at the fastest pace in decades.

The Fed’s approach is to effectively squash demand. Unfortunately, by crushing demand, the shares of the companies that supply that demand fall, and fall. The average market multiple has dropped by a third from 21 to 14 today. Unfortunately, we may not be near the bottom yet. The company’s earnings revisions have been few and far between. Once companies start posting lower earnings expectations, you can expect another leg down. Now let’s turn our attention to the third and final major issue, supply chain disruptions.

Supply chain disruptions

For the US, the COVID pandemic is all but over, but not for China. This has caused a significant imbalance between supply and demand. At present, major Chinese port cities have been put on full lockdown. A second problem stemming from this is that not only is that particular port closed, but adjacent ports become overloaded with traffic as ships attempt to divert to open ports. Additionally, supply chains were already in disarray due to general “deglobalization” efforts that began during the depths of the pandemic. Meanwhile, demand for goods and services has remained elevated due to the strong nature of the US housing market, even in the face of higher rates, mainly due to a lack of supply.

Furthermore, the war in Ukraine has caused an entirely different problem for European and US supply chains. Putin’s war against Ukraine has led to crises in the supply of several basic products, such as crude oil, natural gas and wheat, since Ukraine is the proverbial breadbasket of the world. This has also fueled inflation, causing the price of groceries and gasoline to skyrocket. I can tell you from personal experience that my grocery and gas bills have doubled. The question now is, will this bear market turn into a full-on recession? Let’s discuss.

Is a recession coming?

Since the Great Depression there have been 17 bear markets, nine of which eventually led to a recession. Therefore, it is not a given that we are definitely headed for a recession. I have been in the business since the early 1980’s and in the markets since 1994. In 1982, I was in the construction business building apartment complexes when everything ground to a halt. Liquidity had dried up completely. We didn’t get paid for the last resort we completed. That was a great lesson learned for me. I ended up joining the famous 10 of the US Army.the Mountain Division to get money for college. It was a corporate bloodbath that lasted for years.

I don’t feel like we’re in such a bad shape this time. The inflation of the 1970s was much worse than what we are experiencing now, as I recall. I feel the Fed is way behind the curve, the odds favor at least a shallow and short recession of some kind. Fed Chairman Powell has almost assured that we are in for a hard landing, at the very least, based on his latest comment. In times like these, my primary focus is capital preservation rather than appreciation. It’s time to run away and live to fight another day. Let me explain.

Capital Preservation Over Appreciation

I raised cash during the last quarter of 2021 on most of my high-growth stock picks in my speculative growth portfolio as many of my trailing stops were removed. Subsequently, I did not choose to return to the charges. I always set up an exit strategy for my speculative growth and momentum trades using a trailing sell limit stop order and a sell limit order at a certain point above my target profit target.

In my long-term income and dividend plays on my SWAN income portfolio, I set buy limit orders at lower levels to increase my yield and reduce my base. I’ve put some new money into AT&T (T), Ford (F), Verizon (VZ), and Bank of America (BAC) recently. But not a large amount. I still have plenty of dry powder ready to roll out when it looks like the coast is clear. Now let’s take a look at what that entails.

When will the coast be clear?

Funny how it seems as soon as we declare that we are in a bear market or a recession, it’s over. Well, we’re not so lucky this time. However, some areas of interest show signs of peaking. The following is a list of possible positives as I see them.

  • It seems that inflation has peaked. However, it can remain high for an extended period of time.
  • US port congestion has eased. Also, there is no longer a shortage of truckers based on my trucking contacts at the moment.
  • Commodity prices have not fallen, but their rate of increase has slowed.
  • Oil and gas prices should eventually fall as rig counts recover and hopefully the Ukraine war ends soon.
  • Home prices have stabilized instead of the seemingly unstoppable upward march that we have endured for the past two years. We have over 5% mortgage rates to thank for this.

So it’s not all bad news. Now we are going to button this piece.

the up button

I want to start off by saying that the worst thing you can do is panic and sell out on the bottom. The thing to remember in times of market turbulence is “this will pass.” The market has recovered from every bear market and recession and is higher 100% of the time. If I am worried about a certain position or portfolio, I will buy put options for protection and/or sell calls for additional income. Many times, I use weakness to increase my dividend and income positions. My saying is “bad news and buying opportunities go hand in hand”.

Over the years I have learned that the exact moment I felt like selling was the right moment when I should have doubled down. I’ve disciplined myself not to get emotional about the decision. I do additional due diligence at that point and determine if security is down due to idiosyncratic reasons, or simply because the baby was thrown out with the bath water.

To conclude, I would say that we are closer to the bottom than the top. It’s time to start putting together your shopping lists. I use the drop in futures price to earnings ratio as my first screen when looking for buying opportunities. Not just price. The S&P 500 growth stocks that have seen the largest percentage declines in forward price/earnings based on my latest analysis are AMD (AMD), Qualcomm (QCOM), and Nvidia (NVDA). I also like Apple (AAPL) here for growth. I’m still researching new earnings prospects, but AT&T, Verizon, Bank of America (dividend growth) and Iron Mountain (IRM) are positions I’ve already added to. I would buy more Exxon (XOM) but my basis is currently in the $30s with a 10% yield so it would not be beneficial for me at this level.

Final note

The stock market is under pressure as I finish this article. There is a great art to investing in highly volatile markets like these. It involves layering into new positions over time to reduce risk. You want to have a lot of dry powder if the stock you are interested in continues to drop. As a Winter Warrior Veteran of the US Army’s 10th Mountain Division, I was instilled with the attributes of patience and perseverance, hence my investment motto “patience equals profit.” Here is a picture of me hiding in my snow cave waiting for the storm to pass.

army

Winter Warrior Training ft. Drum, New York (Staff)

Take your time and build new positions slowly, at dollar cost averaging. Also, use articles like these as a starting point for your own due diligence before putting your hard-earned money at risk. Those are my opinions about it, I hope to read yours.

Your input is required!

The true value of my articles is provided by the prophetic comments from Seeking Alpha members in the comments section below. Do you think we are headed for a recession? Why or why not? Thanks in advance for your participation.

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