We all have insurance of some kind—health, auto, life, disability, renters, and/or home.

Just in case …

When we drive, we have our seat belts and lots of new safety features for our car, like airbags.

The roads have markings, safety engineering, and guard rails on the riskiest stretches.

Just in case …

When doing our taxes, we employ an accountant or use expert-prepared software to do our taxes.

When we sell or buy a house, most of us use a real estate agent or at least review Zillow or some such software to get an idea of value.

Need a new furnace or air conditioner? You call an HVAC company to make sure it is done right.

Just in case …

In the kitchen, the pantry has canned food, and maybe it’s stocked with bottled water.

If there are young children in the house, there may be covers on the outlets and latches on the cabinets.

If there’s a newborn that’s joined the family, there’s likely to be apnea detectors and/or a room monitor.

If there’s an elderly person in the home, extra precautions in the bathroom, bed rails on the bed, and a necklace with a button to summon help are likely to be evident.

Just in case …

I could go on and on with examples of how we seek to protect ourselves and our loved ones from the common dangers of everyday life. And whole articles have been written about why each of the examples given is a wise step for us to take.

There are at least three elements common to all of the examples: (1) a real danger exists; (2) multiple, redundant protections are usually recommended; and (3) the need to act in advance of the danger is necessary to mitigate the danger.

Yet when it comes to investing, investors seem largely unaware of these elements. And the farther investors progress into a bull market, the farther the thoughts of the danger seem to recede from their consciousness.

Until, that is, we have a period like what we have been going through since the January 26th peak in the stock market—then, the fears and anxiety surface.

Do your investments qualify for the “just in case” risk management that applies to much of our everyday life? Let’s look at the three elements.

  1. Is the risk real?

Since just 2008, there have been 11 market corrections equal to or greater than 10% in the S&P 500. Most of these have seen the uptrend quickly restored.

S&P 500 Bull and Bear Market corrections

Since the beginning of 2000, there have been three bear markets (defined as a decline of about 20% or greater). While one of these was just 19.4% in 2011, the other two resulted in more than 50% loss of principal. Each of these declines took over seven years to get back to breakeven. Since the top in 2007 was close to the top in 2000, it works out that it was actually around 14 years with no gains!

The danger is real.

  1. Multiple types of protection

It has usually taken more than one type of risk management to mitigate this danger. Incredible numbers of investors choose to simply track the domestic stock market with their portfolio, usually with passive index funds that are clones of the S&P 500 and NASDAQ 100 Indexes. These indexes contain lots of stocks, thus diversifying the risk of investing in a single company where the loss can be total. Yet, just as they track the index to the upside, they also track the indexes on the downside (note the NASDAQ 100 fell over 70% in each of the two major declines this century).

Most investors using financial advisors and planners diversify a second way: among asset classes. Yet the last two major corrections have taught a hard lesson. When the broad market indexes decline here in the U.S., most of the diversifying asset classes fall as much or more!

The only true diversifiers are bonds, gold, and other commodities. Yet as a bull market progresses, the allure of having a higher and higher percentage of the portfolio in stocks grows. People adjust their answers to suitability profiling questionnaires to take on more risk. They fail to rebalance, and the equity percentage automatically grows higher. They see the indexes soaring while their diversified portfolio trails, and they ask their advisors to assume more risk.

When the inevitable bear market occurs, they learn what risk really is. They suffer losses closely approaching the indexes they were trying to catch a few months prior.

The true “just in case” investor employs more risk-management approaches than index investing and asset-class diversification. They employ dynamic risk-management strategies and strategic diversification (diversifying by actively managed strategies as well as asset classes). Their portfolios are filled with “plan B” investments that can provide redundant risk-avoidance mechanisms.

These “just in case” investors realize that, like insurance, these protections have a cost. They understand that you can’t have one foot out the door and do as well as a market index that is always fully invested. They know that you can’t take suitability into account and always carry gold and bonds in your portfolio without trailing stocks when they are rallying. And when the market fakes them out and a correction doesn’t turn into a bear market, they realize that the small loss that was taken was done to be correctly positioned if the bear market had occurred.

  1. Acting before the danger arrives

Finally, “just in case” risk avoidance requires the investor to put their preventative tools in place before the loss occurs. Just as one cannot wait for the auto accident to occur before buying the auto insurance, investors can’t wait to add risk management beyond diversification until after the market loses 20% or more. Just as risk is always with us in the financial markets, we’ve found that it’s best if these risk-management tools are always employed as well.

Just in case a 10% correction turns into a bear market.

Just in case a 20% downturn in your index fund morphs into a 50% mega bear.

Just in case the time to get back whole again extends to seven years … or 14.

Dynamic risk management—just in case …

Market update

Last week in the stock market was ugly. For the second time this year, the market indexes retreated over 5%. Hopefully, this time, as was the case the first time, it will be like an army that returns to its base to refresh itself. But to investors, it seemed more like a rout.

In full retreat mode, everything in the equity markets took a hit last week. As is often the case, the best performers when stocks were rallying—techs, financials, and the NASDAQ 100 Index—also took the biggest losses as stocks sold off.

The president’s announcement of tariffs to be levied against Chinese goods, and the Chinese response threatening tariffs of their own, caused many to believe the first shot of a new trade war had been fired. Like the shot heard ’round the world, such a war could have world-changing implications as the two largest economies square off.

The trade numbers are disproportionate. While over 20% of our imports are from China, only 8% of our exports go there.

China share of US Trade

Despite the market and the media reaction, the Chinese rejoinder so far has been fairly mild. They threatened tariffs on $3 billion in goods against the president’s levy on about $60 billion. And this morning, it became clear that trade representatives for the countries were already talking. Furthermore, the Chinese announced they were willing to work to open their country’s markets to more U.S. businesses. Stocks, so far, have responded and risen substantially today.

While bear markets have to start somewhere, 5% down weeks have a mixed record of forecasting. Of the 29 5% weekly declines since 1987, only 11 saw further declines the next week, while 18 of the following weeks saw gains. Similarly, three months later, stocks were up two-thirds of the time.

Still, with the decline following that January 26 market peak, the 7% loss that has occurred since the March 9 recovery high has been serious. We are now back into “correction” territory (a loss of greater than 10%) since the January high watermark. All of the domestic stock market indexes except the NASDAQ have losses year to date, and both the international developed markets (EAFE) and emerging markets (EMM) have also sunk below breakeven for the year.

Even bonds are negative year to date, with stock index-like losses. Only oil and gold have managed 2018 gains.

As the following chart discloses, we hit, almost exactly, the support level I suggested last week, and both the long-term bullish trend line and 200-day moving average provided the predicted trampoline bounce today.

S&P 500 Last Year

The question now becomes whether that bounce will diminish, like the trampoline user’s often does, or gain energy and cause the user to obtain new heights.

There are a number of reasons I think the latter is more likely than the former. First, when we reached support we were in extremely oversold territory. Unless we are going to decline into a new bear market (2,296 would be 20% below the January 26 highs), the trend line and oversold levels have been able to turn the market around every time so far since the 2009 beginning of the present bull market.

Secondly, the interest-rate environment has improved a bit. Rising rates were a secondary reason for the decline in stocks so far this year. But since their peak, bonds yields have actually fallen significantly and seem to have stabilized.

This was in part caused by the Fed action and pronouncements last week. The minimum increase in interest rates was announced. This was as expected. Less certain had been the tenor of the first official words of Jerome Powell, the new chairman of the Federal Reserve. But these turned out to be sage, overall dovish, and comforting to Fed watchers.

Although this suggests less interest-rate pressure on stocks, I am still concerned. The Fed has an enormous inventory of bonds acquired in its moves to turn the economy around. It had been embarked on a sale program targeting $20 billion per month. Very little of those sales have occurred so far this month, however, and now the Fed has announced an increase in the monthly sale program to $30 billion. This could have negative repercussions on bonds and stocks.

Economic indicators seem to have paused in their weakening. This is most apparent in the status of the Conference Board’s Index of Leading Indicators. It beat analysts’ estimates and gained more than expected. As a result, the ratio of the leading to coincident indicators continues among the indicators I have been reporting on that have a good track record at calling recessions but which are not presently doing so.

As the following chart discloses, recessions are usually preceded by a downturn in this ratio. No such turnaround is evident.

Market Indicator not signalling recission

As your “just in case” advisor, I’m happy to report that our intermediate-term strategy indicators have been signaling a riskier environment and reducing our allocation to equities. All except Classic have backed off from stocks.

Why do they do this?

Just in case …

But then, why do they continue to have any exposure to stocks?

Just in case …

All the best,


Jerry C. Wagner is Founder and President of Flexible Plan Investments, Ltd. Formerly a tax and securities attorney, Mr. Wagner recognized early on that technology and hedge fund techniques could be applied to help individuals successfully invest, while managing their downside risk. After spending time pioneering new techniques in market analysis, designing quantitative methodologies, and managing investment portfolios, Mr. Wagner founded Flexible Plan Investments in February 1981.

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