Perspective is key during major market movements. And so we proactively communicate our thoughts to clients when those happen, especially if on the downside. Yesterday, August 5, was such a day. LNW CIO Ron Albahary, CFA recorded a video with this thoughts (see below) and also wrote a message providing perspective (see text below video).
Given the lows in equity volatility during the past several months, we have been writing about how markets have underappreciated the risks to the economy as well as the geopolitical and U.S. political risks. We featured a key stock market volatility index (the VIX term structure) as anticipating a spike in U.S. equity volatility, in our July commentary to support our thesis.
While we take a balanced approach to evaluating economic indicators, we have been emphasizing (more so than the financial media) those factors indicating the economy is slowing. The negative data on unemployment (rising to 4.3% in July from 4.1% in June, the fourth straight monthly increase), the relatively low number of new jobs created in July along with the ongoing drop in manufacturing activity have reinforced that trend and are key catalysts for the sentiment and directional reversal.
Notably, the U.S. unemployment report has now triggered an excellent predictive indicator of recession called the Sahm Rule, created by former Fed governor, Claudia Sahm. It triggers when the three-month unemployment average rises 50 basis points above the previous 12-month low. In our recent internal quarterly investment review, we highlighted that the unemployment rate breached 4% after a record period of 27 months below that. Six other comparable streaks in history dating back to 1949 led to recession. Unemployment’s trajectory is inertial when it breaches 4%, meaning it has historically accelerated to the upside.
We are not making the recession call as we do not make predictions. With that said, we do believe recessions are not extinct and one will occur at some point. We also believe market volatility has been abnormally low for a protracted period of time given all the potential risks that can rattle markets. Thus the importance of owning shock absorbers in portfolios in your strategic, long-term allocation (we do not attempt to be tactical – something that increases decision risk, especially the risk of being wrong).
As we have seen time and time again, inflection points in sentiment and market direction happen quickly, violently and cannot be anticipated. Now, with these recent sentiment reversals, investors are seeing the risks we have been highlighting, including the elevated probability of an escalation and expansion of the war in the Middle East. The U.S. is sending carriers and Turkey has even threatened to get involved unless a peace deal is made.
For investors, now is the time to stay unemotional, disciplined and hew to your long-term investment plan. Every client’s situation is different. In broad strokes we have been advocating trimming equities into the surge; adding to what we call “Diversifiers” (i.e. hedge funds and private credit); topping off core fixed income or evaluating whether to move to a less risky strategic asset allocation (if client goals can still be achieved with a high probability). Rebalancing client portfolios with maniacal discipline is crucial to compounding wealth over time. Taxes are important but there shouldn’t be a zero tolerance to realizing capital gains.
