Trading Desk: Nothing Ventured, Nothing Gained

In the silence that surrounds a long market weekend, a quote from a recent news article keeps circulating in my mind: “it seems like most people aren’t as concerned with making huge gains as they are with simply protecting their assets.”

If that reflects your current emotional posture, don’t worry. It’s been a rough couple of years and in the face of persistent threats, a lot of investors are more than a little burned out. I’m not going to judge you.

Sooner or later, we all hit a point somewhere between frustration and exhaustion . . . when it just doesn’t seem worthwhile to keep fighting the Wall Street undertow for every percentage point of traction. That’s when we fold our hands, take our chips off the table and head for the sidelines in pursuit of a lower-stress life.

That’s when we retire from the market. Like I said, I’m not going to judge you if you’re in that place after three bear runs in five years, not to mention a pandemic, at least one brief recession and an interest-rate whipsaw savage enough to kill a few banks.

But I am going to argue with you one more time before you exit the game. The sidelines are quiet, but while nothing truly terrible can happen to you there, nothing truly good can happen either.

You won’t lose a lot of money. You’ll be safe. But you won’t make a lot of money. You’ll never move up in the world. And again, that’s all right . . . if that’s what you truly want.

As we say on Wall Street, you can’t reach for positive returns without accepting at least a little risk that something will go wrong and interrupt the route to your goal. The flip side of this basic truth is that when you eliminate all risk, you cut out nearly every driver of returns.

And in that scenario, you leave yourself wide open to inflation, taxes and the cost of living itself to drain your portfolio. Over a long enough timeline, you’ll end up watching your net worth deteriorate. Locking yourself out of risk perversely guarantees that sooner or later, you’ll lock in a loss.

But life is all about opportunity. When we stay open to the unknown and ambitious enough to ask for more than what we have now, there’s a chance we’ll end up disappointed . . . but with a robust investment strategy, there’s a better chance that we’ll end up ahead of where we started.

Isn’t that why we get involved in the market in the first place? Let’s take a little time this weekend and weigh all the math. The results might not get you excited about Wall Street right now, but I’m hoping it gives you a little more nerve to hang in there.

How Much Longer?

After all, if you’re in the market right now, you’ve already demonstrated herculean patience. You’ve kept your cool through the longest bear market since the 2008 crash, swallowing month after month of downside volatility.

Sooner or later, every market with a downside bias has always flipped back to a more constructive environment. The fear that drives the bears doesn’t necessarily evaporate, but every single time, optimism, hope, ambition and greed ended up stronger than dread.

Wall Street climbed the wall of worry. Over the past century, the market spent 22% of its time in the grip of the bear and the rest of life running with the bulls. That’s the equivalent of one bad day and four good ones in every week.

And with the S&P 500 still in bear territory after roughly 16 months, the current downswing has started pushing statistical limits every single day. The end is literally in sight. Quitting now might come as a relief, but it also locks you out of the recovery.

Consider: if you cash out of stocks now and buy bonds, you might lock in close to 4% on the right day. Great. You’ll never need to worry about losing money in the market again.

But until the Fed gets inflation under control, you’re still losing 6% of your purchasing power every year. In the best scenario, 10-year bonds held to maturity will be worth the equivalent of 80% of what you paid . . . and the intervening coupons will pay you back enough to leave you 20% ahead after accounting for inflation.

In the worst scenario, inflation stays where it is and you’ve just locked in a significant loss in purchasing power, a guaranteed loss in real terms. Admittedly, there’s no headache and no anxiety. You know exactly what yield you’re locking in . . . and there’s always the risk that stocks will fall harder over that timeline.

However, there’s also a chance that stocks will do better. This is actually the safer bet. In the worst historical scenario, someone who bought the S&P 500 at the 1999 peak and cashed out in the 2008 crash ended up with a 33% loss.

The moral there: don’t sell the crash. We don’t have to worry about buying the peak right now, so that risk isn’t a factor. As long as even that hapless investor who bought into the dot-com bubble resisted the natural urge to liquidate in 2008, Wall Street has always provided a better exit that actually keeps up with inflation and leaves the investor feeling rewarded for the experience.

On average, a decade in the S&P 500 means close to 8% a year. While you’re rolling the dice from year to year, that math compounds well enough over just about any reasonable 10-year period to leave long bonds in the dirt.

Every day you aren’t in stocks, you run the risk of missing out. About half of all the really great days for the S&P 500 happen either late in bear markets or in the first couple of months of a new bull cycle. You miss those days, you cut yourself out of the real upside experience.

And if you’ve already felt the bear’s bite and your net worth is down 10-20% from its 2021 peak, how fast are you going to recover lost ground at the rate of 4% a year in nominal terms, 2% above the Fed’s inflation goal and -2% when measured against inflation today?

It’s fine if you want to just surrender those lost paper gains. But if you resent the bear, use that anger to get back in the game. What you want is offense, not defense.

Are we in a new bull cycle? I’d like to think so, but we won’t know for sure until the S&P 500 can comfortably hold 4,500 again. Until we get that confirmation, everything is theoretical.

But are we late in a bear market? Definitely. The clock is ticking. It might be another six months or six weeks before the bull really comes back, but we’re close enough to the statistical edge that I don’t want to miss any of the fireworks.

Everything depends on inflation at this point. If prices level off, corporate profit margins will expand in relief. We’ll see the earnings trend go positive again . . . and that’s generally good for stocks.

How The Bear Dies

What about a recession? Earnings already reflect one. Mainstream companies like McDonalds (MCD) are already laying off people. But that’s exactly the solution to the Fed’s challenge: when the economy is running hot enough to generate inflation, you need it to cool off.

The economy is bigger than it was when the yield curve started waving the red recession flag, even after adjusting for inflation’s bite. There’s still progress. Stocks have a reason to be higher than they were beforehand . . . not lower.

The only reason stocks have lost ground is that they soared too high on the Fed’s zero-rate updraft. That’s why I focus on the comparison between the pre-pandemic era (2019) and today, and not on year-over-year numbers.

Back in 2019, interest rates weren’t extremely high but they weren’t zero either. We were in something like a normal world. Draw a line between two points in time where conditions were relatively “normal” and you’ll get a better sense of which companies are actually doing work . . . and which are cheap and which are still expensive.

The longer companies that are bigger than they were in 2019 trade at levels below where they were back then, the closer we are to Wall Street finally acknowledging that these companies are cheap. The more companies in that position, the more upside is built into the market as a whole.