Is There Anywhere to Hide in This Market? One Word: Cash

Nowhere to run and nowhere to hide. One of the simplest ways to tell if you are in a bull market is to study the 50-day moving average of prices versus the 200-day average. Sounds too simple? Probably, but according to data from Ned Davis Research, for the last 122 years holding the Dow Industrials when the 50-day was below the 200-day, which has been about 1/3 of the time, returned a big zero (dividends excluded). Holding when the 50-day was above the 200 returned 8.4%/yr. If you have other simple strategies that have created over 8% of alpha per year for 122 years, you are likely comfortably retired!

The Dow Industrials are not one-of-a kind either. Gold, silver, crude oil, the US dollar, and bonds exhibit the same technical behavior. There is an entire asset management business built on this concept called managed futures strategy, but I don’t want to digress. What is the indicator saying now? Stocks, bonds, and gold are all in bear markets. Only cash is in a bull market. As such we view short duration treasuries that yield 3+% as a good cash proxy to generate some incremental income.

Rarely, but certainly now, there are moments in global capital markets when seeking safety and seeking positive returns can become very challenging and the opportunities are quite limited. Are we in this type of environment? Perhaps. All the fundamental, tactical, and technical factors lead us to conclude that at present returns for equities, fixed income and gold all look challenging. While bear markets certainly have counter bear market rallies, trading those counter trends is extremely challenging and there is significant risk if you get the ‘trade’ wrong. So, we do not recommend this as a predictably successful strategy.

So where does that leave investors if, in fact, we are facing a low/negative return environment across all asset classes? We believe there are several actions to consider and position your portfolio to withstand these headwinds.

1) Diversification is still essential: When it comes to wealth preservation, having a highly diversified portfolio is critical. The key is to make sure that the asset classes are uncorrelated. In our view, there are only 4 major asset classes: equities, investment grade bonds, precious metals (aka hard currency), and cash. Each of these then has many sub-asset classes. Try to classify all your holdings in one of the above four. An example would be owning a Real Estate Investment Trust (REIT). It helps diversify your equity portfolio, but it is likely highly correlated to equities so don’t think of it as bond which could lead to trouble.

2) Commit to the long term: Find durable investment ideas that are not fully priced and use short-term weakness to accumulate more. Your edge here is that Wall Street research that thinks about the next 5-10 years is obsolete; the current holding period of NYSE equities is a half year; when I started investing it was closer to 4 years. Be prepared to do some analysis and test your hypotheses constantly.

3) Know what you own and whom you are invested with: While this may seem obvious, now is the time to ‘kick the tires’ even harder. Evaluate and assess whether you truly understand the funds, stocks and other assets you own. Rather than ask only what the upside potential is, consider also what the downside risk is for each investment you have. How will a recession affect your investments? How has the fund manager performed during prior cycles?

4) Stay close to home: It is critical that one understand the risk/reward characteristics in your portfolio, and seek investments with lower beta, which can be thought of as the relationship between correlation and volatility. This could include both dynamic hedges, and/or investing with managers that actively hedge their exposures, lowering their beta relative to an underlying benchmark. Now is not the time to be overly exposed in any asset class leaving you precariously positioned out on the risk curve.

5) Seek uncorrelated assets: The term uncorrelated assets is probably the most over-used and least accurate way to describe almost ALL investments that are categorized as such. We believe finding TRULY uncorrelated assets is challenging because it is critical to determine whether, both quantitively and qualitatively, they are not correlated to the capital markets in any way. It has taken us over a year to build a portfolio of these assets that invest in areas that are not tied, connected, or exposed to equites, fixed income or gold. While building a portfolio exclusively of uncorrelated assets that are illiquid is not prudent, we believe allocating single digit exposure to them is appropriate in this market environment.

6) Liquidity is king: Now is a good time to assess how much liquidity you need for the next 24 months. I am not implying that is the duration of this bear market, but it is important to have a margin of safety when it comes to your liquidity. The last thing one wants to do is face liquidity issues in a recessionary environment.

I opened this article indicating that we may be an environment in which there is nowhere to run and nowhere to hide, but in fact that certainly does not mean there is nothing to do. In fact, now is the time to review/assess the items listed above and create a personal checklist of items to consider and act upon. When reflecting and looking back on your portfolio returns, how one manages during bear markets is as important than how one performs during a bull market. Just remember to always keep running and that cash (safety) is in a bull market!