The preservation of the principal is essential: the markets perched on the precipice of pain

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There are a time to make money and a time not to lose it. Have been now in a time not to lose money. A time to focus on preserving your capital as even the market pillars begin to crumble. the the market sell-off has become a complete sell-out. Even Apple’s trusty haven (AAPL) has cratered 25% since the start of the year.

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Apple Chart (Looking for Alpha)

The old school wisdom of Wall Street says that when you see a major market stalwart like Apple begin to crumble, we are on the brink of pain. In fact, we will definitely have entered bearish territory if the S&P 500 drops another 10 points and closes at $3,837 or lower, which would be exactly 20% off its highs, officially ending the bull market.

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S&P 500 Chart (Looking for Alpha)

The hammering of Walmart (WMT) and Target (TGT) stocks as the companies lacked earnings was a disastrous sign that consumers were beginning to tighten their belts. Additionally, the Nasdaq (QQQ) is already firmly in bearish territory, as it is down 30% year-to-date.

nas chart

NASDAQ Chart (Looking for Alpha)

What is to blame for all this market chaos? I boiled it down to three main factors. In the following sections, I will give a brief summary of each. Let’s start.

Three major market headwinds

Rampant inflation

Inflation is rampant around the world, but especially in the United States. In fact, we are currently at 40-year highs.

CPI rate

CPI rate (Tradingeconomics.com)

Inflation is an insidious tax on the general public. It crept in stealthily and sprouted like a weed before anyone had time to notice. The Fed is immeasurably behind the curve at this point. Commodity shortages caused by supply chain issues and a high level of demand for goods and services as the pandemic subsided are the main culprits. Wage inflation due to low unemployment has also fueled the sharp rise in inflation, as increased labor spending is also factored into prices.

Additionally, while the CPI chart above shows the inflation rate may have peaked, economists believe it is likely to remain at elevated levels for some time. This caused the Fed to drop from 180 dovish to hawkish, which does not bode well for the markets. Here’s why.

Federal Reserve Policy Change

The Fed changed policy on the spur of the moment once its realized inflation was not “transitory,” as Chairman Powell repeatedly assured us. Nevertheless, once he realized they were wrong, he unveiled a plan to tighten financial conditions by raising rates and at the fastest pace in decades.

The Fed’s goal is to effectively crush demand. Unfortunately, by crushing demand, the stocks of the companies supplying that demand fall, and they fall. The average multiple of the market fell by a third, from 21 to 14, currently. Unfortunately, we may not even be close to the bottom yet. Corporate earnings revisions have been rare. Once companies start posting weaker earnings forecasts, you can expect another drop. Now let’s turn our attention to the third and final major issue, supply chain disruptions.

Supply chain disruptions

For the United States, the COVID pandemic is basically over, but not for China. This caused a major imbalance between supply and demand. Currently, major Chinese port cities have been placed in full lockdowns. A second problem derived from this is that not only is that particular port closed, but adjacent ports become overloaded with traffic as ships attempt to reroute to open ports. Moreover, supply chains were already in disarray from the general “de-globalization” efforts begun at the height of the pandemic. Throughout this time, demand for goods and services has remained high due to the robust nature of the US housing market, even in the face of higher rates, primarily due to a lack of supply.

Additionally, the war in Ukraine has created an entirely separate problem for European and American supply chains. Putin’s war on Ukraine has caused supply shocks in several commodities such as crude oil, natural gas and wheat, as Ukraine is the proverbial breadbasket of the world. It also ignited inflation, sending the price of groceries and gasoline skyrocketing. I can tell you from personal experience that my grocery and gas bills have doubled. The question now is, will this bear market turn into a real recession? Let’s talk.

Is a recession looming?

Since the Great Depression, there have been 17 bear markets, nine of which eventually led to a recession. It is therefore not certain that we are definitely headed for a recession. I’ve been in business since the early 80’s and in the markets since 1994. In 1982 I was in the apartment complex building business when everything basically stopped in the blink of an eye. Liquidity had completely dried up. We didn’t get paid for the last resort we completed. This was a huge lesson learned for me. I ended up joining the famous US Army 10and Mountain Division to get college money. It was a commercial bloodbath that lasted for years.

I don’t feel like we’re in such bad shape this time around. Inflation in the 1970s was much worse than what we have now, as I recall. I think with the Fed as far behind the curve as they are, the odds favor at least a shallow, short recession of some sort. Fed Chairman Powell has all but assured that we will at least suffer a hard landing based on his latest comment. At times like these, my primary focus is capital preservation rather than capital appreciation. It’s time to run away and live to fight another day. Let me explain.

Capital preservation versus appreciation

I raised in the last quarter of 2021 on the majority of my high growth stock picks in my speculative growth portfolio as many of my trailing stops were removed. Subsequently, I did not choose to return to the positions. I have always implemented an exit strategy for my speculative growth and momentum trades using a limit sell stop order and a limit sell order at some point above my target profit target.

On my long-term dividend and income plays in my SWAN income portfolio, I set buy limit orders at lower levels to increase my yield while lowering my basis. I recently deployed fresh money in AT&T (T), Ford (F), Verizon (VZ) and Bank of America (BAC). But not a lot. I still have plenty of dry powder ready to deploy when it looks like the way is clear. Now let’s see what this entails.

When will the coast be clear?

Funny how it seems as soon as we declare we’re in a bear market or a recession, it’s over. Well, we’re not so lucky this time around. Still, some focus areas are showing signs of peaking. The following is a list of potential positives as I see them.

  • Inflation seems to have peaked. Nevertheless, it can remain high for an extended period.
  • Congestion at US ports has eased. In addition, there is no longer a shortage of truckers according to my trucking contacts at this time.
  • Commodity prices have not fallen, but their rate of increase has slowed.
  • Oil and gas prices should eventually fall as rig counts have recovered and hopefully the war in Ukraine will end soon.
  • Home prices have stabilized rather than the seemingly unstoppable rise we have experienced over the past two years. We have over 5% mortgage rates to thank for that.

So it’s not all bad news. Now let’s button this piece.

The up button

I want to start by saying that the worst thing you can do is to panic and sell low. The thing to remember in turbulent market times is “it will pass”. The market has bounced back from every bear market and recession and recovered 100% of the time. If I am concerned about a certain position or portfolio, I will buy puts to protect myself and/or sell calls for additional income. Many times I use weakness to add to my dividend and income positions. My saying is “bad news and buying opportunities go hand in hand”.

Over the years, I’ve learned that the exact moment I felt like I was selling out was actually the moment I should have doubled down. I disciplined myself not to be emotional about the decision. I perform additional due diligence at this time and determine if security is down for idiosyncratic reasons, or just throwing the baby out with the bathwater.

To summarize, I would say that we are closer to the bottom than the top. It’s time to start putting together your shopping lists. I use the decline in the forward P/E ratio as my first screen when looking for buying opportunities. Not just the price. The S&P 500 growth stocks that have seen the biggest percentage declines in forward price-to-earnings ratios according to my last screen are AMD (AMD), Qualcomm (QCOM) and Nvidia (NVDA). I also like Apple (AAPL) here for growth. I’m always on the lookout for new revenue prospects, but AT&T, Verizon, Bank of America (dividend growth), and Iron Mountain (IRM) are positions I’ve already added. I would buy more Exxon (XOM), but my basis is currently in the $30s with a 10% yield, so it wouldn’t be accretive for me at that level.

Final remark

The stock market is under pressure as I conclude this article. It’s quite an art to invest in markets as volatile as these. This involves layering new positions over time to reduce risk. You’ll want to have plenty of dry powder if the stock you’re interested in continues to drop. As a Winter Warrior veteran of the US Army’s 10th Mountain Division, the attributes of patience and perseverance were instilled in me, hence my investment motto “patience equals profit”. Here is a photo of me hiding in my snow cave waiting for the storm to pass.

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Winter Warrior Training ft. Drum, NY (Staff)

Take your time and slowly build new positions, averaging the dollar cost. Also, use articles like these as a starting point for your own due diligence before putting your hard-earned money at risk. These are my thoughts on the subject, I look forward to reading yours.

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The true value of my articles is provided by the prescient remarks of Seeking Alpha members in the comments section below. Do you think we are heading into a recession? Why or why not? Thank you in advance for your participation.

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