Markets Update: The Rotational Bear Market — War & Inflation

What started as a normal correction in stocks after a meteoric rise in 2020-21, has turned into a bear market in some sectors of the economy. We thought we would share a few thoughts about recent changes we’ve made to your portfolio considering these market changes, Ukraine, and the Federal Reserve’s quagmire to temper inflation.

The Fed’s Quagmire

In the final weeks of 2021, many of the market's previous "highfliers" declined dramatically as market participants envisioned an economy that had reached cruising speed. This is common in economic recoveries when entering what we call Phase II. Investors tend to focus on more reasonably priced securities, with more consistent earnings – an environment that we welcomed at the start of the year. However, since that time the world has witnessed a confluence of confusing data points – runaway inflation has put pressure on the Federal Reserve to raise interest rates, along with an outright war in Ukraine. Together these situations have created greater market volatility, uncertainty, and a conundrum for the Federal Reserve. While they would like to raise rates in their quest to beat inflation, the tensions in Eastern Europe are making it difficult for them to do so, exacerbating inflation even further. Rising inflation left unattended is detrimental to the overall health of the economy and financial markets. This muddled environment is already having negative impacts on sectors of the market such as banks, select technology companies, and consumer discretionary companies – and for good reason. As you can imagine it is also putting downward pressure on European companies and U.S. companies doing business in the region.

To mitigate risk in your portfolio, we have been exiting positions we felt would be negatively affected by these trends. We have also been opportunistic about remaining in sectors that can benefit from inflation or are impervious to it – such as companies in the energy, materials, consumer staples, and healthcare sectors. We also have reduced your overall stock exposure given this environment. We are optimistic about these changes, particularly given that many of today’s problems don’t seem to have an end date in sight.

Don’t Let the Bear Eat Your Profits

As you know, we believe that effective long-term portfolio performance necessitates a change in portfolio structure from time to time as the economy changes or risk increases. We are sensitive to mitigating significant loss and will always do our best to follow through with that endeavor. These recent changes, though targeted at minimizing risk and enhancing return, can create capital gains in your taxable account. Though we know some investors loathe the thought of paying Uncle Sam, the math of paying a tax on capital gains can far outweigh the potential loss of capital by sticking with investments that may fall catastrophically. Our recent changes have created capital gains – mostly due to the extraordinary increase in your portfolio value in the past few years. However, the actual taxes paid on these gains pale in comparison to the losses that one could sustain if a full-fledged bear market unfolds – which it already has in the sectors discussed above. For a great and short read on this subject, please click this?link?to read our colleague, Aaron Stern’s excellent assessment of why taking profits is better than sustaining loss. This can also be found in the newly printed 2nd edition of our Founder and Managing Partner, James Demmert’s book,?The Journey to Wealth?– please let us know if you would like a copy and we would be happy to send one to you.

Cybersecurity and Online Risks

As you may be aware there is some concern that Russia will engage in cyberattacks against the U.S. or other nations’ organizations. Although we believe that a Russian cyberattack is highly unlikely, it’s important you feel that your money is safeguarded from such events. We encourage you to check out Schwab’s resources for staying safe online?here.

We hope this brief update finds you healthy and please let us know if you have any questions about our work.?Our hearts go out to all those citizens affected by the war in Ukraine, while our minds stay focused on managing your assets to the best of our ability during this difficult time.

From all of us on the team, we thank you for your vote of confidence in our work!