Winning More By Losing Less
This month’s headline is shameless plagiarism. When you read as much as I do, you get ideas from everywhere. In this case, it was a Fund Profile article in Barron’s on Rupal Bhansali, the portfolio manager for the Ariel International fund a couple of weeks ago.
Bhansali successfully plays defense by first asking, before making any investment, “What can go wrong?” She takes her goal to not lose her investors’ money personally.
As most of you are aware, we approach investing the vast majority of our clients’ money in a far different manner than most money managers and financial planners. TABR stands for Technical Analysis Based Risk Management. Simply put, we believe defensive strategies are very important in hostile market environments. That’s what we’re in now, so it’s a perfect time to illustrate what “Winning More By Losing Less” looks like.
Some Context On Risk
I don’t want to assume that everyone knows what losing money means in financial markets. It’s all about time frame. The shorter it is, the more disappointed you’re going to be. On average, during the past 100 years or so, stocks lose money on a calendar year basis about 1 in 4 years. It’s rare that a bear market would be bookmarked inside of a calendar year. Those losses can range from a few percent (-2% to -5%) to more than -50%.
Bonds, or fixed income, have typically lost money only in about 2 of every 10 years, going back to the data in 1976 for intermediate bond indexes, with the largest annual loss just over -6%. Until now. In the past, government bonds have typically gone up in value during severe stock market declines, but that hasn’t happened in 2022. Instead, yields have risen from generational lows at an extremely rapid rate, causing most broad bond indexes to be down -10% for the first six months of the year, the worst performance in the history of the data going back 46 years.
The stock market just concluded the worst first six months of the year since 1970, with the S&P 500 falling -20.6%, the Russell 2000 Index of small companies down -23.9%, and the Nasdaq Composite, home of many pricy growth stocks, off -29.5%. Investors have already experienced a bear market, and the odds are quite high it’s not over.
Let me now define Conservative and Moderate, in the context we use them, and most in the industry, for that matter. We define a Conservative allocation as having 40% in stocks and 60% in bonds. Most Moderate portfolios are considered the opposite of that, or 60% stocks and 40% bonds. In our case, our Moderate accounts in the last five years have gone from 60/40 to 55/45 to 50/50 and currently sit at 55/45. We’re looking for an opportunity to move back to 60/40 on lower equity prices from here.
For historical context, one should note that the two worst calendar years for the S&P 500 going back to 1930 have been a -43.8% loss in 1931, and a -37.8% loss in 2008. The former was part of the Depression Crash, where stocks ultimately lost -86% of their value. The top to bottom drawdown during 2007-2009 was nearly -57%. Assuming we’re not going into a Depression again, let’s use the 2008 decline as a worst case one-year outcome.
For a passive, buy and hold investor (more on that in a moment), a Conservative portfolio would have lost over -15% from the stock portion alone. We’ll ignore the details of whether one owns large, small, international stocks, or is weighted to value or growth. Just the S&P 500 for numbers sake. Then there’s the bond side. In 2008, government bond funds gained about 5% for the year, but corporate credit necessarily did not. It depended on credit quality.
To be conservative in our example, let’s assume the bond portion in 2008 contributed nothing–no gains, but no losses. That means a Conservative allocation would have lost about -15% for the year. Up to now, that would have been modeled as a worst case scenario for conservative investors. Then came along 2022. At present, core bond indexes are down -10% for the year. There’s no way to know where they’ll be at the end of December. We are experiencing one of the few times in history when stocks and bonds are going down at the same time. And the bond side isn’t trivial, as it has been in the past.
Let’s say stocks continue the next six months on a downward spiral, and match the 2008 decline of -38%. We’ll give the benefit of the doubt to bonds, thinking that yields would fall from current levels in a recession scenario, and bonds would end the year down about -7%. That would imply a loss for a Conservative allocation of about -19.4%.
Conservative just got a new definition. I’m not saying this WILL happen, but I’m certainly saying it COULD happen. The bottom line, the goalposts have been moved. Where I’m going with this is—if you’re a Conservative investor in a passive, buy and hold portfolio, you’d better be prepared to lose -15% to -20% of your capital at some point without abandoning your strategy. It will only take one stupid mistake of panic to blow up years of gains, which will never be recovered. This is why many in the industry suggest that an investor’s behavior is just as important as strategy. We call it discipline.
Tactical Vs Passive—How It’s Working
We tell clients and prospective clients that beating the market is very hard to do. It’s possible, but not easy. And, it’s not our goal. We feel clients should only take the amount of risk necessary to achieve their goals. Ultimately, we’re trying to help clients get to their goals with a lot less downside risk. This is even more important for retired individuals, who face sequence of return risk. It resonates with most of the people who are attracted to us. They don’t want to go through the above. As a result, the profile of our tactical work is very different than buying and holding.
Below is what’s happened in the first six months of 2022, certainly one of the worst periods since 2008.
| 12-31-21 to 1-31-22 | 1-31-22 to 7-1-22 | Year-To-Date | |
| TABR Moderate Tactical | -4.90% | -3.64% | -8.37% |
| Moderate Benchmark | -15.41% | ||
| TABR Conservative Tactical | -3.93% | -3.84% | -7.62% |
| Conservative Benchmark |
-13.92% |
||
| S&P 500 Index | -5.25% | -15.28% | -19.1% |
| Vanguard Lifestyle Conserv Fund (VSCGX) | -13.69% | ||
| Vanguard Lifestyle Moderate Fund (VSMGX) |
-15.70% |
||
| TABR Passive Index Acct | -4.82% | -11.87% |
-16.13% |
Some disclosures. All of the numbers above are net of management fees and include reinvested dividends. The benchmarks referred to use Vanguard Fund—Total Bond, Total International Stock and Total Stock. The weights for the Conservative benchmark are 10% International, 30% Total Stock and 60% Total Bonds. For the Moderate Benchmark, it is 45% Total Bonds, 41.25% Total Stock and 13.75% Total International.
Let me walk you through what’s transpired with our tactical accounts so you can understand the differences. We began 2022 with a stock allocation which was 80% invested, plus on our bond side, we were 50% invested in high yield bond funds, having sold half the position on November 30. In the first month of the year, everything changed. Our remaining four stock market risk models all turned negative by January 31, as did our remaining position in high yield. At that point, we had 0% tactical stock exposure, and still do. We maintain a 20% floor in equities, using a Total Stock Index fund and 4 Fidelity sector funds. As was previously communicated in these pages, we went into Max Protect mode on January 31.
You’ll notice that during that first month, our tactical accounts were down almost as much as the S&P 500. Where’s the defense? This is where one needs to understand markets. There is no model which can go in and out and avoid small declines. It doesn’t exist. It is the big declines one needs to worry about, like the one we are currently in. Now, take a look at what has happened to our tactical accounts since January 31, compared to TABR’s Passive Index Account, along with the S&P 500.
During that period, the S&P 500 dropped an additional -15.28%, and the Passive Index Account fell nearly -12%. In contrast, our Conservative and Moderate Tactical accounts dropped less than -4% each. At present, they are beating the market by a substantial margin, but more importantly, we are preserving capital in a hostile environment. That’s what we’re supposed to do. Should stocks continue to fall much further, which is very possible, our portfolios will continue to limit losses, which is extremely important in positioning for the next bull market.
And a reminder, in always being balanced in reporting. Though we may put some capital to work near the bottom of this bear market, our models will not instantly turn bullish and go from 0% tactical to 80% invested overnight. Every strategy has a trade off. We will lag when the market turns up, until our risk models suggest it is safe to start deploying capital. That’s the price one pays for avoiding the declines that go from -10% to -20% to -30% and maybe even to -50%.
A Recession Seems More And More Probable
Last month, we talked about the differences in bear markets that are associated with recessions, versus those that are not. Historically, losses in the stock market have been significantly greater during recessions, averaging about -35%. In the past several weeks, more and more economic and company news seems to be suggesting a recession is dead ahead.
Housing stocks have plunged nearly -50% from their peaks. Oil price shocks have nearly always led to recession in the past. The Fed has a terrible record of engineering a “soft landing.” According to Stan Druckenmiller, a top investor and fund manager who at one point ran the Dreyfus Fund and also worked for George Soros and his Quantum Fund, “we’ve never had a soft landing after inflation got above 4.5%. It’s a real longshot.” “Indeed, I think the signals aggressively point to a hard landing.”
Tesla just announced last week they are laying off 10% of their workforce, which means 10,000 people will be out of a job. More and more retailers are announcing disappointing results. The next few weeks, quarterly earnings will begin anew and it will be telling how the results come in across the board. Up to now, Wall Street analysts have not cut earnings estimates (they are notoriously bullish almost all of the time).
The Fed and Chairman Jerome Powell have talked straight about getting inflation under control. The Consumer Price Index is running at over 8%, while the Fed Funds rate sits at 1.50%. It’s almost certain the Fed will raise rates later this month to 2.25% and then we’ll have to see about September. Do they go to 2.75%, or to 3%? At that point, I’m expecting a fully inverted yield curve, which in the past, has almost always been a leading indicator of recession.
In the past two weeks, the bond market may have started to sniff lower growth. Since June 14, the yield on the 10-year Treasury Note has dropped from its peak of 3.48% to 2.88%. Below is the Global Recession Probability Model from Ned Davis Research (www.ndr.com).
At its current reading of 89%, the past history of the model has indicated the probability of a recession 87% of the time. Corporate CEOs are conveying less and less confidence about the future. Perhaps we’re all talking our way into a recession, but there’s no denying the data. Recessions and booms are all about psychology, just like stock market movements.
Sentiment Indicators—Ask Not What They Say, But What They Do
There’s definitely a lot of pessimism out there, and it’s showing up in Wall Street sentiment polls, such as the one depicted below from Ned Davis Research.
This is a weekly poll maintained by NDR since 2006. Sentiment is a contrary indicator. When most people are bearish, its bullish, and vice versa. But, as one can see, bullishness can last for a long time before markets decline, and the same is true of bearishness. Presently, the poll is residing in an area that in the past, has foreshadowed stock market bottoms. But look what happened in 2008. An initial oversold reading of 38 took place during the first quarter, in March 2008. The bear market had another year to go, and much further to fall. Given the highest inflation rate in 42 years, it’s possible we could be in a similar situation today.
Tellingly, what may be more important than what people are feeling, is what they’re doing. According to State Street, the first six months of the year has shown an estimated $170 billion of net inflows into U.S. equity funds, during the biggest six-month decline in 52 years. My take is that in the past 11 years, investors have been conditioned to buy the dip, convinced that every time, the Federal Reserve will come to the rescue. They have, until now. Bottom line, I don’t think investors have capitulated at all. Anything is possible, but until we see hundreds of $billions of outflows and a true intermediate oversold condition, with investors panicking, we’re unlikely to be near the bottom. And the only way to get there is through much lower stock prices.
Breadth Has Confirmed To The Downside
We continue to monitor the number of stocks making new lows on both a daily and weekly basis, in addition to the number making new highs. Stocks made their last closing low on June 17, at 3666 on the S&P 500, and have rallied modestly since then. However, on that day, and for that week, the number of stocks making new lows expanded, reaching their highest levels of the decline thus far. In technical terms, this “confirmed the low.”
A graphic portrayal of this is below, showing the S&P 500 Index and the number of stocks making new lows. The chart is courtesy of our friends at www.decisionpoint.com.
Bottoms and tops in the stock market normally have breadth divergences at major turning points. In this case, that would mean prices going to even lower lows, and the number of stocks making new lows shrinking. In other words, less participation in the downside. That would indicate a lessening of selling pressure. This doesn’t always happen. No method is perfect. It didn’t happen in 2020, but at that point, the Fed stepped in and saved the market, and the decline taking place was not the type normally associated with a bear market.
All we can say is that the bear market in breadth is in gear to the downside, which suggests the probabilities favor lower prices ahead, notwithstanding periodic rallies.
A Ray Of Hope
At certain points in markets, it gets to be so bad, it’s good. That happened a few weeks ago, when the S&P 500 fell more than -5% in two consecutive weeks. This is pretty rare territory. According to our friends at Bespoke Research (www.BespokePremium.com), there have been only 7 other periods since 1945 when this has happened. The data is shown below. If one knows market history, you’ll see the dates have coincided with bear markets of varying severity.
The weakness in this data is that there are only 7 data points. That’s not even close to being statistically significant. It’s all we have, though. With the exception of the 1987 Crash, stocks were higher one year later in all of the instances, with above average gains, though I should add there were additional double-digit losses in four of the cases before stocks began to recover.
Portfolio Allocations
There are no changes in our stock market risk models. All five remain negative, so tactical equity exposure remains at zero, with a 20% floor in sectors and VTI, as noted above. Our high yield bond risk model went negative just two weeks into the signal we wrote about in our last update, and as far back as we can remember, this may have been the quickest SELL signal we’ve ever experienced. It was not the outcome we’d hoped for, but we followed our discipline, and sidestepped substantial losses on June 13. Those funds are back in the relative safety of ultra-short duration bond funds.
At some point, there is going to be a fantastic opportunity in high yield credit and in stocks, but we hope that’s from much lower levels (and higher yields).
More Government Overreach
In outlining this section, I’m reminded of Ronald Reagan’s famous sarcastic quote about minimizing government regulations. “I’m from the government, and I’m here to help you.” Yeah, right. Well, our business of helping clients with their retirement assets just got more bureaucratic and complicated.
The U.S. Department of Labor (DOL) has issued a new set of regulations to financial advisors who give advice to clients about whether to roll over 401 (k) plan assets into an IRA. Specifically, advisors who would receive increased compensation as a result of recommending a rollover must qualify for an exemption from the DOL’s prohibited transaction rules by complying with new standards.
The formal law is known as DOL’s Prohibited Transaction Exemption 2020-02 (PTE 2020-02). It also covers moving from one IRA to another IRA. To qualify for an exemption to this rule, advisors must comply with six key conditions.
Among other things, these conditions include acknowledging that one is a fiduciary (we already do that), along with disclosing in writing to the client the scope of the relationship and any material conflicts of interest. In addition, one must provide written disclosures to clients of why the recommendation to roll over assets is in their best interests.
We are very thorough in our summaries to clients, and once you have a relationship, it is quite common for people to change jobs, or retire, and want to rollover their assets from their workplace plan into an IRA. Today, many custodians will accommodate these requests via a phone call with the client. That aspect will not change, but the time it takes to actually rollover assets or transfer them from one custodian to another will absolutely take longer, because of all the documentation that will be necessary.
We absolutely will deal with this, because it is an important element in serving clients. But you’ve got to be delusional if you think the government, whether it be in Washington, California, or pick your state, is ever really interested in making it simpler to do business.
The new regulation went into effect on February 1, 2022, but as far as the real implementation of it, that just began on July 1. Very little has been written about this in the financial press, but as a firm in our industry who acts as a fiduciary and in the best interests of our clients, it’s important that you understand the new rules and changes that we’ll need to be complying with in the future, which are much more extensive than in the past. Non-compliance is not an option.
Material Of A Less Serious Nature
An old Scottish man paced up and down outside the emergency room at Roodlands Hospital, near Gullane Golf Club. Inside, doctors and nurses were trying to remove a golf ball accidentally driven into a kilt-wearing golfer’s posterior.
The nurse in charge noticed the elderly man and went to reassure him. She patted his slumped shoulder and said, “Everything is under control. Hopefully, it won’t be long. May I ask how you’re related to the patient?”
“Related?” the old Scot replied. “No. It’s my ball.”
Summer Camp at UGA
On Saturday, June 11, I chaperoned daughter Caroline to the University of Georgia to attend veterinary camp for a week. Besides running cross country and track, she is quite interested in going down the vet path, specializing in large animals (think horses). We had the best hosts and hospitality that anyone could ever imagine from my industry buddy, Don Beasley and his wife Georgia, who are intimately involved in the Athens, GA community.
Below is a glimpse of one of the activities Caroline got to experience.
Yes, that’s her right arm inside the cow’s rumen (stomach). She came away pretty passionate this is the path she wants to go down, so in coming months, she’ll be evaluating several different schools besides UGA, including UC Davis, Cal Poly SLO and several others on the west coast.
Meanwhile, son Adam is in the second month of the world tour for Kid Laroi, shooting photo and video as they go all over Europe, after several weeks in Australia. They’re currently in Amsterdam, soon to be in Berlin, Birmingham, London and Manchester later in the month. Laroi’s latest single, A Thousand Miles Away, has reached as high as #15 on the Billboard Hot 100. It’s pretty cool.
Cool doesn’t describe the weather, but enjoy the summer, as it will go by fast. There’s a dearth of sports news in my world, with my Giants struggling a bit lately, and the Angels reverting to who they are–less than average. But, hey, college sports is changing faster than ever with USC and UCLA leaving the Pac-12 for more money. Only in America! Thanks for reading. Your trust and confidence in all of us at TABR is much appreciated.
Sincerely,
Bob Kargenian, CMT
President
TABR Capital Management, LLC (“TABR”) is an SEC registered investment advisor with its principal place of business in the state of California. TABR and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisors by those states in which TABR maintains clients. TABR may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notice filing requirements.
This newsletter is limited to the dissemination of general information pertaining to our investment advisory/management services. Any subsequent, direct communication by TABR with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of TABR, please contact TABR or refer to the Investment Advisor Disclosure web site (www.adviserinfo.sec.gov).
The TABR Model Portfolios are allocated in a range of investments according to TABR’s proprietary investment strategies. TABR’s proprietary investment strategies are allocated amongst individual stocks, bonds, mutual funds, ETFs and other instruments with a view towards income and/or capital appreciation depending on the specific allocation employed by each Model Portfolio. TABR tracks the performance of each Model Portfolio in an actual account that is charged TABR’s investment management fees in the exact manner as would an actual client account. Therefore the performance shown is net of TABR’s investment management fees, and also reflect the deduction of transaction and custodial charges, if any.
Comparison of the TABR Model Portfolios to the Vanguard Total Stock Index Fund, the Vanguard Total International Stock Fund, the Vanguard Total Bond Index Fund and the S&P 500 Index is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the TABR Model Portfolios due to varying degrees of diversification and/or other factors.
Past performance of the TABR Model Portfolios may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above in part because client accounts may be allocated among several portfolios. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable
For additional information about TABR, including fees and services, send for our disclosure statement as set forth on Form ADV from us using the contact information herein. Please read the disclosure statement carefully before you invest or send money.
A list of all recommendations made by TABR within the immediately preceding one year is available upon request at no charge. The sample client experiences described herein are included for illustrative purposes and there can be no assurance that TABR will be able to achieve similar results in comparable situations. No portion of this writing is to be interpreted as a testimonial or endorsement of TABR’s investment advisory services and it is not known whether the clients referenced approve of TABR or its services.