Published on June 9, 2022 in the Rochester Business Journal

Well, it’s official – we’re now in a bear market! Stocks, as measured by the S&P 500 Index (a proxy for large U.S. companies), have fallen by more than 20% from their all-time highs, while the Nasdaq Composite Index (almost half represented by technology companies) and the Russell 2000 Index (a proxy for small, U.S. companies) have both fallen by more than 30% from their respective highs. Even bonds, as measured by the iShares Core U.S. Aggregate Bond ETF and generally considered a safer type of investment, are down by more than 13% from their recent peaks. Right or wrong, markets have priced in a recession, very few things are working for investors, and it’s easy to understand why many people are feeling a sense of despair. It’s also the exact time when investors need to be reminded of the Golden Rule – sell high and buy low.

At the most basic level, the Golden Rule can be implemented by adjusting the mix of stocks to bonds in any given portfolio. For example, for an individual that had a 60/40 mix of stocks to bonds before the correction in the market began, that mix is now closer to 56% stock and 44% bonds (assuming one’s stocks fell an average of 25% and that their bonds fell an average of 13%). Idea #1 – reduce the portfolio’s bond allocation by 4% (i.e. sell high on a relative basis) and increase one’s stock allocation by 4% (i.e. buy low on a relative basis), to restore the portfolio’s 60/40 stock-to-bond mix of assets.

A closer look at one’s domestic to international stock exposure might provide an additional opportunity to implement the Golden Rule. For example, the iShares MSCI EAFE Index (a proxy for large, developed international stocks) is down by more than 21% from its all-time high, faring slightly worse than large, U.S. stocks, as measured by the S&P 500. Moreover, and despite the pullbacks mentioned above, U.S. stocks are still trading at a much higher multiple to expected earnings for the year ahead, versus developed and even emerging international stocks, where prices are at multiples that are at or below their historic averages. Idea #2 – lower the portfolio’s weighting in U.S. stocks (i.e. sell high on a relative basis) and increase the weighting in developed and/or emerging international stocks (i.e. buy low on a relative basis).

There are several other ways to implement the Golden Rule. For example, with large U.S. stocks down more than 20% and small U.S. stocks down by more than 30%, perhaps it makes sense to reduce large U.S. stock exposure and increase small U.S. stock exposure. There are also exploitable disparities between growth-oriented investments and value-oriented investments, the former being characterized by higher growth rates in earnings, higher price/earnings multiples and generally lower dividends, and the latter being characterized by lower growth rates in earnings, lower price/earnings multiples and generally higher dividends.

Would you believe that domestic small-cap value stocks are selling at a lower multiple to earnings (broadly speaking and versus their 20-year average price-to-earnings multiples) than any other part of the U.S. equity market, and that domestic large and mid-cap growth stocks continue to trade at their highest multiples to earnings, versus their 20-year price-to-earnings multiple averages? In this instance, perhaps one could leverage portfolio adjustments even further by trimming large and mid-cap U.S growth stocks and adding to small, U.S. value stocks.

On the equity side of a portfolio, you could continue to implement the Golden Rule by taking advantage of valuation disparities among economic sectors, industries and even individual companies. On the fixed income side of the portfolio, however, things might not be so easy. For example, as interest rates have risen, bonds with the longest duration (think longest maturity) have been hurt the most, meaning their prices have fallen more dramatically than most other parts of the bond market. Does this mean it’s time to run out and buy long-term bonds, in an effort to buy low on a relative basis? The answer is only if you believe the bond market has already discounted all (or nearly all) of the Federal Reserve Bank’s (the Fed’s) interest rate increases, and that the next major move in interest rates is down – probably not likely at the moment…at least not yet.

To the extent the Fed will continue to raise interest rates, and to the extent the market hasn’t fully discounted these incremental rate hikes quite yet, investors may have to wait a bit before they can truly buy low. Eventually, that day will come but, in the interim, perhaps the best we can do is stay invested in areas of the bond market that tend to hold up better than others in an inflationary and/or rising interest rate environment – areas like senior loans, high yield, bonds with shorter maturities and/or higher coupon rates of interest, and inflation-protected, U.S. Treasury bonds.

Markets go up and markets go down. There’s nothing unusual about that, and nothing we can do to stop it. Unfortunately, we’re experiencing the latter right now. The bright side is that drawdowns like this provide opportunity, often allowing investors to turn lemons into lemonade. It’s not a time to panic, but rather, a time to be vigilant and disciplined. In times like these, the Golden Rule can be your friend. There will be times like these, time and time again.

To see this column in the RBJ, click here.