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We have been discussing with our clients whether the recent drop in the stock market represents a buying opportunity at these levels. While any reasonable assessment depends on investor circumstances and time horizon(s), we remain skeptical. The excessive liquidity created by the Federal Reserve is still being withdrawn from the financial system, interest rates are rising, valuations on stocks and bonds are still not in bargain territory, and inflation continues to erode household and corporate earnings.
This will likely be a challenging year for the economy and the markets, despite the welcome recession (though not extinction) of Covid from daily life, decisions and actions. This piece reflects our thoughts on how we are approaching this market environment.
Stock and bond prices continued to swoon in April with the S&P 500 falling -8.7%, bringing the year-to-date loss to -12.9%. What is also alarming investors is the price performance of large technology companies that had reached a status that was deemed almost unassailable just a few months ago.
The QQQ exchange traded fund tracks the NASDAQ index of the 100 largest companies in that index. This is considered a “blue chip” index of technology companies, and the underlying index that the fund is based upon has increased in value each year for the last thirteen years. Even with the -8.9% first quarter loss, the index has compounded at 19.7% per year for a decade.
A significant decline from these types of returns is not unexpected because returns of this magnitude are not sustainable. Predicting these dramatic market moves is very difficult, and that is what we choose to avoid with solid strategic diversification and smaller relative tactical shifts. We do show below a visual representation of the recent period returns in comparison to those in the "dot com boom” era at the end of 1999.
Resonant sets client parameters for risk tolerance in discussions with our clients that fits with the assumed rates of return in their financial plan. We do not seek to time the stock or bond markets based upon our short term views, though we publish our thoughts quarterly to give clients our thinking on the economy and markets.
What We are Doing
In October, 2019, the major custodians eliminated commissions from stock trading. The timing of this could not have been better (or worse) as the arrival of the pandemic in early 2020 created an environment very supportive of stock speculation with few costs and ultimately, abundant liquidity.
Because Resonant is concerned with reducing the “friction” of taxes in our client portfolios and there is now no longer a commission cost involved, our clients have noticed an increased level of trading activity as the market has declined. We are taking advantage of this decline to swap out of capital loss positions and move into comparable investments, either through Exchange Traded Funds (ETFs) or individual securities. We think of these accumulated recognized losses as a “tax loss bank” that you can use at a later date to offset gains realized when the market is stronger.
The market decline has also reduced the embedded gains in many mutual funds that have long been in client portfolios. Because ETFs are typically much cheaper than mutual funds, are far more tax efficient, and trade just like common stocks, Resonant is using this decline to move out of mutual funds and into comparable ETFs.
So while we are not making a market call, our efforts are designed to reduce long term costs while minimizing negative tax impacts over the longer term. A stock market decline gives us this opportunity, and we have been taking advantage of it for Resonant clients.
