Federal Reserve’s inflation shift (characterized by banknote, gold and market graph line)
“Don’t fight the Fed” was the bullish rallying cry that started in 2010. While there were stumbles along the way, the Federal Reserve’s decade-long easy money policy saw long-term bonds and stocks perform well.
So, where is that chant today?
It is being ignored because that would mean cheering for a bearish investment strategy. Importantly, don’t interpret that silence as meaning the Fed’s interest rate raising and bond selling will have beneficial effects. Whenever the Fed tightens, it knocks down the economy along with the bond and stock markets. Naturally, investor enthusiasm and consumer optimism follow suit. The problem is, those unhappy conditions are required to tamp down rising inflation.
Last Wednesday’s Fed-induced bond and stock market drops, followed by Thursday’s and Friday’s failed attempts to reverse them, show that nervousness is alive in Wall Street. Therefore, now is the time to build cash reserves. The alternative, waiting to see where Wall Street’s anxiety takes the markets next, is too risky.
But aren’t there stocks that could benefit during this period?
Yes, but the odds of finding one and then sticking with it are low. A market downturn from a period of widespread popularity takes time for stock prices and investor attitudes to fully adjust.
The best time to hunt for opportunities is near the bottom, when there is widespread negativity. Of course, that’s when the wisdom of buying low is hardest to follow.
So, when will we know the bottom is here?
As always, the bottom will occur when the thought of buying a stock produces emotional turmoil. (Everyone gets such feelings, even seasoned professional investment managers.)
The coming period has the risk of being particularly bad. (See “Here Comes An Inflationary Storm Like None Before” for the explanation.) If so, attitudes will have been shaken severely by the time the stock market’s fall finally ends.
Riding out such a period while being fully invested would require disconnecting from the world. Most developed, and many lesser-developed, countries are in the same predicament as the U.S. Therefore, expect plenty of negative news ahead.
The bottom line: Cash reserves in risky times provide a sound mental state and an important investment resource
Dealing with risk is a challenge because it is never certain. It is the probability that something bad will happen. Choosing to stay fully invested in such a period can lead to serious financial losses and feelings of guilt and failure.
Holding cash reserves can prevent distressing financial harm and a debilitating mental state. As with insurance, cash offers investors the protection and peace of mind necessary to continue looking forward and making good decisions.
Moreover, cash reserves are a powerful investment tool. They allow taking advantage of opportunities during late bouts of emotional selling.
Disclosure: Author holds 100% cash reserves
For more discussion of inflation and coming period, see articles listed in John Tobey’s profile:
Depiction of stock market selloff bottom