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Kim Khan talks to Steven Cress about navigating market turbulence (0:10). Protecting portfolios with a barbell approach (3:00). Tariffs and market sentiment (5:20). This is an excerpt from a recent Investing Experts conversation.
Transcript
Kim Khan: We’re talking about market turbulence and how to navigate rough waters with Seeking Alpha’s VP of Quant Strategy Steven Cress.
I don’t bandy the words prophetic or soothsayer around a lot, but I will say it in this case because you wrote this article February 25th on strategies to help the investors who are navigating a tough market, and it’s kind of only gotten worse.
When you wrote the article, we had fear on the greed and fear scale. Now we’re in extreme fear. We have the VIX (VIX) at the high of the year. We’ve got the S&P (SP500) battling its 200-day moving average. We’ve had all the gains since election day wiped out.
What are your thoughts on what we’re seeing right now in the market?
Steve Cress: Well, first and foremost, we’re likely at the beginning stages of what’s going to be continued uncertainty, and the market hates uncertainty. The market can normalize a bull period, the market can normalize a bear period, what markets really don’t like is uncertainty.
And we know, historically, when there’s uncertainty out there, that’s when we’re at maximum volatility and the maximum corrective phases.
What just adds to the uncertainty here is we’re beholden to what’s happening in Washington. Up until this point, the economy was in fairly good shape.
Earnings for most corporations were in pretty good shape, but a lot of policy changes, executive orders, are making it difficult to navigate the environment right now. And that difficulty is what’s giving the market pause, and it’s forcing a rotation to defensive sectors such as consumer staple, utilities, and real estate. And what people do, during those rotational periods is, they typically sell stocks that have given them the best performance.
So they want to take some of their profits, especially if you’ve been in a stock for a couple years, it’s nothing to take a little bit off the table. Unfortunately, if you’re just buying into those stocks that have strong fundamentals, you’re caught with bad market timing. It doesn’t mean that the companies don’t have good fundamentals, it just means that many of the existing shareholders are taking some profits. And when they all do it at the same time, it has a big impact on stocks.
People shouldn’t let that market volatility scare them. They should keep calm. Carry on, really remain disciplined. One of my mantras for Quant is that it’s built on a belief that fundamentals ultimately prevail, and history shows that periods of market turmoil often create the best opportunities for patient investors.
So we’re going into one of those periods now. We don’t know how long this correction is going to last. We don’t know if it’s going to deepen. In this environment, I’m recommending somewhat of a barbell approach. And in a barbell approach, we want to protect our portfolio. And to do so, we could rotate into stocks that pay dividends.
Dividends and their ability to generate income help provide some downside, I should say, to those stock prices because they’re supported by yields.
On the other hand, we also don’t want to ignore some of the incredible opportunities that we’re going to see. I would say Quant Systems often perform like a Richter scale.
We started writing that article at the end of February, but even before the end of February, before you can even see a real rotation occurring in the markets, we started to see stocks that had really strong fundamentals weaken.
I can’t tell you how many times I’ve seen this over the last 30 years being focused on Quant when we have these portfolios that seem to have great fundamentals. All of a sudden, the prices just start coming off. I look back to the 2007 period, I look at what was happening right around the pandemic, how companies that had excellent momentum and really strong fundamentals just started in unison coming down.
So, I really feel like the Quant as a Richter scale. When we begin to see shakiness in the stocks, usually, there’s a long-term negative impact coming to the economy and the overall market.
And I don’t think this was any exception because we really started to see this occur in late January and into February. So the guidance that we have is, it’s very much related about tariffs and the impact that that’s going to have on inflation and interest rates. We don’t know from day-to-day what’s going to happen with these tariffs. So, that’s why I think it’s really smart to approach this with that barbell approach. You want to give yourself some downside protection with stocks that generate income, but you don’t want to ignore companies with good fundamentals.
Because, really, and historically, these stocks that have these Quant Strong Buys, when a market comes off by 10%, 15%, 20%, the Quant Stocks actually come off before all the other stocks. So at that point, they’ve already come down.
And I usually find that a great point to get into these stocks because the stocks with good fundamentals often rebound the sharpest to the upside, and it really, really pays off so I think a barbell approach would be really smart here.
I think people want to have faith that the current administration, they’re making the right moves, but nobody’s quite sure. So they want to give it the benefit of the doubt.
I don’t think anybody is selling all their stocks. I don’t think they’re completely rotating into the defensive sectors as I mentioned before. So it’s a wait and see approach, and I think investors are taking it day-by-day.
A lot of corrections, especially after Presidential election years, the corrections could be 15% to 20%. But what’s really interesting is, in those periods for the year after the Presidential election year, when the market comes down by that amount, it actually finishes higher by the end of the year.
This might not be any different, especially since we have a very active President in the early days of his administration people are going to want to see what’s happening.
And I think, most economists and most investors are expecting the tariffs to be somewhat inflationary, but there are also other directives that are occurring that could help reduce that inflation. And in the long-term, it’s yet to be seen what’s going to happen. So that’s why I don’t think you’ve seen this complete capitulation of people panicking and selling.
KK: If you look at Warren Buffett, people were criticizing his cash levels in Q4, and then all of a sudden they’re saying, hmm, maybe he was on to something.
But again, Buffett always says he’d rather have his money in equities going to work than have it on the sidelines in cash.
SC: Along the lines of what you’re saying with Warren Buffett, I think, he’s been there in the markets for a long timeץ I’ve been in the markets for a long time as well.
We know historically what happens when tariffs are put forward, and then it escalates into actual tariff wars. So we know from history how markets react, and that’s why you tend to be a little bit prudent when you hear somebody saying, we could be going into a period of tariffs.
And as I said, we take it day-by-day. Many people believe that the tariffs are being used as leverage for negotiations. So that’s why there’s not that complete certainty that you abandon ship. Raising some cash back in December, January, February is a good thing.
Right now, I don’t know, the markets are already starting to unwind a little bit. So I think that’s why it really pays to rotate into certain stocks that have a little bit more of a defensive feature, not necessarily putting everything into utilities or consumer staples, but looking for those dividend stocks.
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