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It’s a Feature, Not a Bug

By:  Aaron Anderson, CFP®, CFA, Partner & Financial Analyst


September 27, 2022

 

Last quarter was disappointing to say the least. In my last article, When Will it End?, I was hopeful that the S&P 500 index being down by at least 1% for four days in a row early in June might mark a bit of capitulation – the last bit of strong selling that tends to happen before markets recover.

The disappointing part is that I was right … for a little while. Despite all the issues, the market seemed to have moved on. That is what tends to happen during a market recovery; there’s even a saying for it: “climbing the wall of worry”. The market is forward looking so despite all the things people still worry about on Main Street, Wall Street decides it’s priced in and the buying begins. Values of equities rise and then the rest of the economy eventually recovers as well. That’s why market timing is such a bad idea: by the time you feel good about buying, you’ve missed a lot of the returns.

But, my (our!) hopes have been dashed by a confluence of factors:

  • A higher-than-expected inflation number was reported in early September. The Federal Reserve has said that they were going to do whatever it takes to get inflation under control, including pushing the US into a recession if needed. You can see from this chart that they mean it – they’ve raised rates more in a shorter time than they have in my lifetime (some say too much too fast to overcorrect from saying inflation is “transient” and not doing anything earlier, we’ll see). [1]


  • At the Federal Reserve meeting in mid-September, the Fed Chair said that a soft landing is still the goal but they’re focused more on getting inflation in check. A soft landing would get inflation under control without tipping the economy into a recession and he’s basically saying that they’re still aiming to do that, but it’s not as likely to happen as they hoped and they don’t care.
  • September is typically the weakest month of the year when it comes to equity returns. I had hoped that the poor market we’ve had all year might alleviate that, but it hasn’t. It’s obviously not possible to tell how much of the poor performance can be attributed to September and how much to the previous two bullet points, but it’s safe to say that it being September didn’t help us weather the news better.

So, unfortunately, as I write this, the market is back to the lows from June. The hope was we’d never see those again, but here we are.

There’s a saying in software development, “It’s a feature, not a bug.”, that refers to things working as intended but that might appear to the end user as a flaw in the programming. For example, the end user clicks a file and presses Delete, but the file is not deleted (bug); the behavior is as intended since the end user didn’t have administrative permissions to delete the file (feature).

The thing to remember is that during bear markets, there can be times where large bear market rallies occur. The market seems to be righting itself, something causes it to stumble, and lower it goes.

Here is a chart from the Great Financial Crisis in 2008 that shows multiple bear market rallies of up to 24% before it did finally bottom out in early 2009. [2]

 

In case you think it’s a more recent phenomenon or not common, here’s one from the Great Depression that took YEARS to work through. [3]

 

Unfortunately, it’s impossible to tell in the moment whether it’s a bear market rally or the first step of the new bull market. Just after what’s shown on the previous two graphs is the next bull market; after having lived through all the hopes of a rally being dashed multiple times, it would be pure luck to say “this is the real bottom” and invest. Somebody will get lucky, call the bottom correctly, and be forever praised on CNBC. The vast majority who get it wrong will be forgotten to the annals of time. We'll only truly know in hindsight when it’s too late to make a decision.

So, we recognize this is normal to have disappointing bear market rallies. It’s a feature, not a bug. Market history shows that returns tend to be good on average even a year out from the start of a bear market and so we continue to position portfolios to try to take advantage when things do turn around.


Last quarter, we started discussing why we hold the stocks we do. Before doing that again, I’ll start with the same disclosures as before:

  • While we tend to use a similar investment mix across all accounts held with us[4], you may not hold some of these positions mentioned here – maybe it’s not appropriate for your goals and risk tolerance or maybe you didn’t have funds available at the time and we didn’t want to sell any of your holdings to make some available.
  • This is NOT a recommendation to buy or sell. It is an “after the fact” report of why we hold what we do. There is neither enough information given here to make an informed decision nor anywhere near the amount of analysis we do on our holdings or prospective holdings. You can of course assume that we have positive expectations for any of our holdings, otherwise we would have sold them. Beyond that, what is stated here is a backward-looking report at what occurred, not a forward-looking prediction of expectations.
  • We are long term investors and so what happens quarter to quarter is not something to focus on. Our best performer one quarter might be our worst performer the next, so again, you should not make investing decisions based on what’s discussed here.


Better Performers:

  • AAPL: Apple needs no introduction. They are the largest US company by market cap and tends to be where people look when trying to find a company with relative safety but good growth prospects. They recently released the next generation of iPhone which tends to increase their revenues as people replace older models.
  • ENPH: This was a great performer last quarter and continues to be for us. We still believe that there is a strong case that solar power will be one of the main ways forward for clean, renewable energy and that Enphase is well positioned to be a leader in that space. If you noticed sales of Enphase in your account it was to take profits on the big moves it’s had recently, not because we dislike it.
  • TSLA: Tesla is the premier electric car company that everyone else is trying to emulate. It was purchased as a growth pick; as the country transitions to electric vehicles, Tesla is the one with the biggest head start both in market share and in mind share.

Underperformers:

  • T: As the disclosure says, a great performer one quarter might be a poor one the next and that’s what happened to AT&T. They had a strong earnings report, but some of their guidance was downgraded which caused them to take a hit. As we said last quarter, we still believe in the long-term prospects and will collect the high dividend while we wait.
  • NVDA: Perplexingly, even though there is a microchip shortage, chip companies have been getting a bit beat up. Nvidia is a top chip producer in artificial intelligence, data centers, automobiles, and gaming. The demand for their gaming graphics cards has decreased as cryptocurrency values decreased since those cards are also used to mine crypto coins. But, we believe the demand is going to stay strong in all of their areas, including graphics cards as they recently released a new generation at higher price points. We continue to be a buyer of cheaper shares as the price has decreased.
  • IAC: The best way to describe InterActiveCorp is that they are a collector and incubator of online brands. They create or purchase a brand, grow it until it becomes well-known, and then spin it off into its own public company. Unfortunately, rising interest rates and slowing ad sales have hurt them recently, more so than many of our other holdings.

New Positions:

  • None: We have not purchased any new positions this quarter. You may have a position in your portfolio that is new to you, but not a new holding for the overall firm.

Sold Positions:

  • OKTA: We still like Okta and what they do as a company, but as we saw last quarter, they have been an underperformer. So, we decided to sell it for the time being and put that money into Crowdstrike. Crowdstrike is also an internet security company but we believe the company (and the stock) has better prospects at recovery going forward.


[1] Source: Kathy Jones on Twitter: "Pace of rate hikes. #FedDay https://t.co/kquHBtygvk"

[2] Source: How bear market rallies trap dip-buyers and frustrate investors (yahoo.com)

[3] Source: 7 Weeks of Rally, Did it Put You to Sleep? (tradersdaytrading.com)

[4] I say “similar” because we customize portfolios based on differing goals, risk tolerances, and timing of transactions. So, the size of positions and account performance, both in absolute and relative terms, will be different.

 

Content in this material is for informational purposes only and not intended to provide specific advice for recommendations for any individual.  All performance referenced is historical and is no guarantee future results.  All indices are unmanaged and may not be invested into directly.

The Standard & Poor's 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Stock investing includes risks, including fluctuating prices and loss of principal.