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Last week may have been a surprise to most, but it was not a surprise to those who read my newsletters. Things actually got a bit spooky there for a minute—the VIX got up to 29, up almost 10 points in a single day.

Some points here:

• The economic data has been bad for a while, going back about two months. The payroll number should not have been a shock, but it was.

• Breadth has been terrible for a while. It improved somewhat with the recent small-cap rotation, but it was still bad.

• Market concentration had reached record levels.

• There was rank speculation in Nvidia and semiconductors.

• The yield curve continues to steepen, and you usually get a recession when the yield curve is steepening.

Anyway, I could go on for another 15 bullet points. You get the idea.

One salient point I want to make: There is no stronger force in the capital markets than “buy the dip.” The “buy the dip” mentality is strong. I spoke with some retail index fund investors over the weekend, and they said they shoveled a bunch of money in their retirement accounts. Multiply that over millions of people, and you get an idea of the flows coming into the market. People have been trained that stocks always go up, and every dip is a buying opportunity. Until the dip turns into a bigger dip, and that dip turns into a bigger dip, and then you’ve martingaled yourself out of existence.

Let me just say that I don’t think we’re going to get off that easy. We’ve had a decade of excesses building up in the market, and it’s not going to be unwound in a few weeks. It’s going to take months or years. But… we will get a face-ripping rally first. (Note: I am writing this on Sunday, August 4.) We need to suck everyone back in one more time.

Recession Talk

I do believe that we will get a recession. Why? Because we have a business cycle, and we have periods of overinvestment and underinvestment. We had a recession during the pandemic, but that really didn’t count, and the last recession we had before that was the financial crisis. Sixteen years without a recession. I’d say that we’re due.

The thing about the business cycle is that it has lengthened. If you go back 50–100 years, we’d have a couple of years of expansion and then a year of recession. Recessions were fairly frequent, but not too severe. Now, we hardly ever get recessions, but when we do, they tend to be serious. I do not think that this will be as severe as the financial crisis. Not a chance of that. 

But it will be severe, and one reason for that will be the unwind of private equity. Private equity has $8 trillion under management, $8 trillion in private businesses managed by 33-year-old MBAs, who will not hesitate to cut payroll at a moment’s notice. You will see unemployment pick up rather rapidly. As you know, it already has picked up to 4.3%, but it will pick up more than that, to about 6–7% in the near term. And a decline in valuations of private businesses will result in a decline in valuations of public businesses—and vice versa. You will see valuations decline across the board.

A question I probably get about once a month about The Awesome Portfolio—why have bonds in there? Bonds suck! Well, last week was a pretty good reminder as to why you have bonds in your portfolio. Recessions are difficult to predict.

Blindsided

If you were one of the people who was blindsided by the sell-off last week, don’t worry; you still have time to reduce risk. The average person is down 5–10%, depending on what they own. This presents an interesting behavioral finance problem. 

Do you wait for the stock market to come back so you can sell it on the highs? You don’t want to sell it now, but if the stock market did get back to the highs, you wouldn’t want to sell it there either. This is how people end up losing a fortune in the stock market because nothing will get them to sell, and they only end up selling when things are really bad, eventually locking in the losses.

Let me put it another way. If the stock market is causing you stress, there is one thing you can do to reduce your stress: sell. You will instantly feel better. I know this from experience. If you have a position that is underwater, you stare at it all the time, it causes you stress, and as soon as you liquidate it, the stress goes away. If for no other reason, do it for your mental health. 

Lots of people would tell you not to do this—you have to stay invested after all and keep compounding. And this is true. So, the goal is to stay invested in something that you can compound without a lot of volatility, like The Awesome Portfolio and my Strategic Portfolio.

Good luck out there.

Jared Dillian, MFA