The 2022 Bear Market + Our Investment Moves

To Sandbox Clients and Friends,

The economy, stocks and bond markets are feeling plenty of pain from 40-year high inflation (higher costs, lower supply) coupled with a bear market (-20% or more) for investors. These are treacherous times for consumers and investors alike, for all the reasons widely published by mainstream media and highlighted in our many Sandbox market commentaries and updates this year. Tony Dwyer says it best, “Bear Markets are natural and normal until you are actually in one.”

Our Thoughts on Inflation & the Bear Market

We have stressed that there is no rush to be a buyer (even for long-term new money) in this current environment, and capital preservation is important right now. For current investment holdings, it’s impossible to time markets but with little clarity for the next 3-6 months, inflation remains enemy #1. The S&P 500 is down -21%, Nasdaq down -31%, Core Bonds down -13% in 2022, which is gut wrenching but similar to past cycles. This “bear market” is very different than past ones due to the cause and path to a solution.

Previous bear markets saw deflationary pressures (“prices decline”) where the solution was solved by trying to re-inflate the economy. Essentially, creating “inflation” via stimulative Govt (“Fiscal”) and Federal Reserve (“Monetary”) policies so that the businesses and consumers had access to cheap money (ie. low interest rates). This bear market is the result of excess stimulus from the pandemic, continued supply chain shortages and now supply shortages from the war in Ukraine. The result is high demand and low supply = high inflation.

To cure high inflation, you need to “deflate” prices, meaning reduce “demand” by making access to money more expensive or less attractive (ie. HIGHER interest rates). The unfortunate collateral damage being deflated asset prices for investors. This is an environment that most investors have never lived through, and the reason why we believe there may not be a “quick solution.” Inflation numbers are released monthly, followed by a Federal Reserve meeting to decide on the direction of interest rates, so as we get more inflation data over the upcoming 3-6 months, we should begin to see a path forward. The hope is that inflation peaks over this time and businesses, consumers and investors can begin to plan accordingly. Until then, we have also been much more active in trying to manage risk and better position your investment accounts. We thought it would be helpful to provide a glimpse into what we have been doing for investors this year.

Disclosure: The portfolio changes listed below are 1) not universal to all accounts and may not impact your account(s), 2) long-term, buy-and-hold does not mean set-and-forget, as risk mitigation is often required during difficult markets, 3) this storm shall pass, like all other markets corrections, however we expect continued market turbulence for the months ahead with more clarity 3-6 months out.

What We Have Done

Stocks Exposure: We have reduced the % allocation to stocks to better manage short-term downside risk
Stock Style: Shifted from overweight growth to value as investors repriced high P/E stocks. Also remain overweight large cap, high-quality, blue-chip companies.
Stock Geography: We remain overweight U.S. stocks, having sold one international manager and sold our only emerging market position due to China regulatory headwinds, strong dollar, and weaking macro picture
Investment Structure: Sold many actively managed funds in favor of low cost, index-based funds
Bonds: Substantially reduced interest rate risk by rotating from core bonds funds to cash alternatives (Rising Interest Rates = Decline in Bond Prices)
Cash: Raised Cash levels by reducing stocks and bonds
Added two new positions in energy to gain exposure to under owned areas of the market that are exhibiting strength
Increased allocation to non-traditional assets (stocks/bonds) by using more “alternative” strategy funds (ie. Market Neutral, Hedged Equity, Premium Income, Real Estate)

Some Positives in 2022

Private Real Estate via Blackstone (+6.26% YTD, 4.5% yield) and Blue Rock (+12.90% YTD, 4.63% yield)
Private Credit via Blackstone (+2.0% YTD, 8.1% yield)
Alternative Investments, using various strategies that have helped dampen downside risk and are outperforming stocks and bonds on a relative basis
Millennium Multi-Strategy Hedge Fund (+5.70% YTD)
For clients with dry powder and cash deposits, we are waiting for more clarity on the direction of inflation/interest rates (3-6 months) before slowly phasing cash into investments

Opportunities in a High-Risk Environment

Income Notes (we target a 5-year maturity, target 8-12% annual interest, with 30% downside protection on coupons/interest and 40% downside protection on principal)
Growth Notes (we target a 5-year maturity with 30% downside protection on principal with an upside multiplier for outsized upside participation)
Hold and Raise an above average cash balance to dampen volatility and have “dry powder” to tactically invest back into markets as the primary risks begin to subside (or if we get to even more extreme levels).
Staying defensive over the next 3-6 months to mitigate against further downdrafts in markets (more cash, remove interest rates risk, less growth, less active risk, more portfolio diversifiers)
Remain Disciplined, have an investment plan and remember that panic is not a strategy, nor is greed.

Perspective: History of U.S. Bear & Bull Markets

This is an important chart for all investors that illustrates the average length and magnitude of past BULL (“positive”) and BEAR (“negative”) market cycles. All BEAR markets feel horrible and watching your investments lose value is incredibly difficult to stomach. We understand the “investor experience” is an important part of making prudent long-term financial decisions and that is one reason we have made some the changes outlined above. However, the duration and magnitude of past BULL markets have far exceeded that of the BEAR market, even if you study past recessions and inflationary environments. We know things are tough, we understand, and we are investors alongside you, but we encourage you to maintain perspective, hold extra cash and buckle up for a choppy few months ahead. This will eventually pass; we’ll begin to invest some of the preserved capital for much brighter days ahead.

If you have questions or would you like review your financial plan or investment accounts, please contact your Sandbox Financial Advisor or Contact Us for a Complimentary Investment Plan Review. We’ll happily schedule a call, zoom or meeting to discuss the changes we have made and the investment plan for you specifically going forward. Enjoy the start of your summer!