I’m undertaking a 1000-day reinvention project, blogging here daily to track my progress. In Friday Flash, I share an epiphany or aha moment from the past week.
Lately all I can think about is the Middle Eastern conflict and the consequent upheaval in financial markets. I am not a buy-and-hold investor so I have raised a large proportion of cash in the accounts I manage, selling out many profitable positions to book gains. I also have one big IRA managed by an outside advisor that I’m mostly leaving be, though I have thoughts of asking him to sell some positions as well.
Monday’s stock market rally failed, and the S&P 500 is now down around where it closed last Friday. The index is hovering right at the 200-day moving average (6652). However, a quick check of my international value ETFs shows they are not looking quite as bad as the U.S. markets. But they are also looking quite poor, technically.
I’ve sold most of my precious metals positions with my gold profits far compensating me for my losses on silver. With silver, I was wooed in like a sheep at the parabolic top. I will not be doing that again. Because of that experience, I’m being cautious with oil and gas related equities and energy commodity plays right now. While that is basically the only sector currently doing well (aside from short and other bear ETFs), they already had a huge run up before the conflict even started. I’ve taken profits on many of those positions, and I’m attempting to be patient waiting for better setups, understanding that I may sit in cash for many months. As the market chops around, it would be easy to lose money thinking, “Now I can get in!” only to watch the situation sour again.
I should revise that to say that there is another area of the market that is doing reasonably well: managed futures funds such as the two I hold $DBMF and $CTA. These funds invest like hedge funds do, in a variety of long and short positions in futures such as interest rate futures, commodity futures (including oil), and precious metal futures. Because they go both long and short and they follow trends of what is doing well, they can often serve as an uncorrelated position that does well when standard beta positions like an investment in the S&P 500 or the Nasdaq 100.
The challenge with these managed futures funds is they are very spiky and can give you large losses unexpectedly when the trends they’re following switch rapidly. For example, many of them have been long gold futures for a while, and that is putting a drag on their performance. But they are also long oil futures, which has helped matters.
There are other “liquid alts” that can help your portfolio in times like this: systematic macro funds, equity long/short, equity market neutral, options trading, and more. If you are worried about what’s going to happen to your savings, you might look into these if you haven’t already.
What does the history of oil shocks suggest?
U.S. equities have generally performed poorly during geopolitically-caused oil shocks. Here’s a chart showing the NASDAQ Composite index (different than the NASDAQ 100 which many people invest in, it includes almost 3000+ stocks listed on NASDAQ) with the spot West Texas Intermediate (WTI) crude oil price, via @mark_ungewitter on Twitter.
Here’s how much the S&P 500 index fell during each of these events, via Gemini (take with a grain of hallucinogen):
| Event | Max Drawdown (Peak-to-Trough) | Months to Bottom | Time to Full Recovery |
| 1973 Oil Embargo | ~48% | ~21 months | ~7.5 years (Nominal) |
| 1979 Iranian Revolution | ~17% | ~20 months | ~3 months (Post-bottom) |
| 1990 Gulf War | ~16.9% | ~3 months | ~6 months |
| 2022 Ukraine Invasion | ~25% | ~9 months | ~15 months |
You might say, “But wait! The U.S. is now a net energy exporter so it shouldn’t affect us!” But note that the 2022 Ukraine invasion showed a long grind down and 15 months to show a recovery, in 2023, when enthusiasm for AI kicked off with the launch of ChatGPT. Then you might say, “but the Fed was raising interest rates to combat inflation!” Indeed, and the Fed is facing a failure to control inflation even before this conflict started, so we might see that same setup again.
Where are we in the business and stock market cycle?
I’ve been rereading Mastering the Market Cycle: Getting the Odds on Your Side by veteran investor Howard Marks. He suggests that one of the most important things an investor can do is to determine where we are in the economic, business, credit, investment, and other related cycles.
We have been in a bull market since the October 12, 2022 bottom that followed the rate-hike shock (and the Ukraine invasion oil shock). Some analysts would say we’ve been in an even longer bull market — perhaps 13 years starting in April 2013, when the S&P 500 finally broke out above its 2000 and 2007 highs, or even 17 years, starting in March 2009, when we saw a generational low following the Great Financial Crisis.
Secular bull markets have lasted on average 18 to 19 years post World War II, so this one could have longer to run. But there is evidence we are reaching the end:
- Credit spreads have been narrow, indicating lenders aren’t asking to be compensated for taking on excess risk
- Companies are engaging in wild capital expenditures on AI data centers without a guaranteed ROI
- The U.S. stock market has reached extreme valuations, suggesting investors have moved to the greedy side of the investor psychology pendulum
- There’s evidence that there is a significant portion of private credit loans that will default
- The labor market is looking weak at the same time inflation is high
This phase in the cycle typically foreshadows a recession or other contraction in business and economic activity, which is what we might expect to happen in the near future. The stock market is a leading indicator, so it will likely fall and then recover before a recession happens.
Taking action and then being patient
This is a time for action and then patience. Action: to reduce risk at a time when risk is increasing. Patience: to wait while the markets grind down or go sideways for a time.