The half ended 6/30/22 is reportedly the worst first half of a year in many decades, depending on the index you are looking at. The extended stock market has been hit much harder than the large cap and especially Dow 30 stocks. If you are looking to trade against the trend and pick up a reversion-to-the-mean wave, look at buying into the hard hit extended market, Russell 2000, and small caps generally. Strangely, the downdraft has not hit the S&P SmallCap 600 the same way. It was off its 52-week high high of 1466.02 on 11/8/21 by about 23% as of mid-day Thursday 6/30/22 (1132.34 when I looked), somewhat less than NASDAQ. Why not buy into the NASDAQ index? Because the peak NASDAQ includes participation by tech names that were genuinely overextended in 2021, including TSLA, NFLX, NVDA, and FB. This also means that while it might seem "safe" to be in large caps that have not been dragged down as far (PEP is a good example), they are more likely to underperform the general market in the next 24 months. The market is willing to accept lower prospective returns because of the premium on safety right now.
In the long run, you want to have a higher allocation to small cap stocks anyway, so if you are currently underweighted in small caps, this might be the time to shift some assets there. SBBI still applies, especially after a substantial correction from market highs.
Three Ideas
With current inflation at 8.6% or thereabouts, you may be feeling some pressure to deploy cash. Consider adding to a small cap index fund. As just stated, it is likely oversold, at least relative to the rest of the market. If you believe in value (as opposed to efficient market random walk theory), then it is discounted to where it was last year. And if you do believe in efficient market theory, there is no reason to believe that from this price, today, that it won't rise as should, so you ought to be buying small caps even if you don't believe in fundamental equity valuation as a cause for investment return.
The next thought came from my blind spot: Saving bonds. It took a Twitter post to wake me up to this, but Series I savings bonds are currently paying 9.62%. That is not a typo; Series I bonds contain a fixed interest rate component and one tied to the CPI measure of inflation. The only catch: You are limited to investing only $10,000 per year. It is worth pursuing because even if inflation subsides, this is an asset class that should be kept in your awareness anyway. For those approaching retirement, this is an excellent way to store some of the cash that you need to keep on hand against bear markets.
And that brings me to target date mutual funds. The theory is that most investors who save for retirement will eventually need to withdraw the money and live off it, but that withdrawals during bear markets would consume unfortunately large portions of the portfolio, assuming constant dollar withdrawals. The mitigation for this is keeping portions of cash and bonds in the portfolio as a buffer against bear markets, and the proportion kept in more stable assets then increases with the investor's age and presumably decreasing time horizon (until death). Target date mutual funds automate with process. It has become very popular with companies offering 401(k) and 403(b) plans, so much so that many companies have eliminated 90% of the mutual fund options they formerly offered, with target date funds making up as much as 90% of the choices available to the employee.
This sad state of affairs is driven in part by theories of behavioral economics: Most people know little about investing and theoretically make poor choices (like not investing at all, and failing to pick up the free money offered to them via the company match), so the company and its hired mutual fund company instead play defense. Choice theory says that people given too many choices make none. So to help people make a choice, the company strips down the choices to just money market, bond fund, international fund, stock fund of some sort, and target date funds. Theoretically, most of the asset categories are there, but this induces employees to make a very substantial mistake.
The problem is with bonds. As I wrote in 2012, and which has remained true for over 10 years, the long bull market in bonds (circa 1980 to 2010) is over. When you start from low yields, it is difficult to make capital gains with bonds, and obviously the yield isn't going to make up for that. Mature target date funds (e.g. 2020, 2025) are loaded with bonds, and although the 2020 and 2025 target dates should involve relatively stable assets, with bond yields so low, they have suffered nearly as badly over the past 12 months as more aggressive equity mutual funds.
Yields have risen a little. 10 year Treasuries traded up to 3.5% in the last few weeks, then rolled back. From this level, it is now theoretically possible to get cap gains from bonds, so you might make a little more money from bond funds in 2022 to 2027 than you did from 2010 to 2022. Maybe. I would still hesitate to make much use of bond funds or target date funds until inflation is lower (not until mid-2023 perhaps) or 10 year Treasuries are at 4%. For those in their 60s or retired, I would shy away from target date funds and make more explicit use of money market and equity funds, and the Series I savings bonds mentioned above.
The third idea involves hedging gasoline costs by investing in oil stocks. While gas at $4.50 to $6.00 per gallon is quite painful, you could mitigate it by investing in oil equities that are sensitive to the price of gasoline. The basic procedure: Figure out a time horizon, perhaps two to three years, and estimate how much gasoline you will need to buy over that time. Then estimate how much that will cost at prices of $4.50 per gallon vs say $3.00 per gallon. The difference is the amount that you now can attempt to capture through equity investments like OXY, CVX, XOM, PSX, SHEL, COP, BP, MPC, VLO. If gasoline continues to be expensive, you will do well in your oil investment. If gasoline drops in price, you get the benefit of reduced expenses. You will need to decide whether this is a serious hedge or just a psychological salve; as I wrote last week CVX is at a price that is too high if oil prices revert to $40 to $60 levels. Losing money on an equity investment may not sound like a good idea, just because you hate paying $80 for a full tank of gas. Of course, that is what makes it a hedge, if you want to make real money, make a prediction that is accurate and act on it beforehand. You can decide whether this is a token investment of 10 shares of XOM to make you feel better, or a serious prediction that world oil markets will be disrupted indefinitely.
The true benefit is the idea, the option to trade this as a hedge. You can obtain more control over your future net expenditures if you want that. Stock market pricing will be chaotic, and might even move the stock price in the wrong direction, but having the option to hedge may provide you with more of a feeling of control, more "thinking space" with less emotion and fewer cognitive mistakes.
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