The S&P 500 entered an official bear market on June 13, prompting a flood of fearful headlines proclaiming worse is ahead. Last month we cited a statistic from FactSet that found when the S&P 500 has fallen at least 15% in the first six months of the year, as it did this year, it has risen an average of 24% in the second half. Lo and behold, July saw the S&P 500 bounce back +9.22%. While we can’t be sure mid-June’s lows are the bear market’s bottom, the upturn since fits the pattern. We advised that nothing about a bear market magically changes what you should do with your investment portfolio.
Selling in response to adverse market action risks missing any rebound, such as the one in July, and turning this year’s disappointing market returns into actual losses. The father of value investing, Benjamin Graham, wrote almost a century ago, “The investor’s chief problem – and his worst enemy – is likely to be himself. In the end, how your investments behave is much less important than how you behave.” This quote is particularly relevant today as investor sentiment is negative. True, many scary headlines have converged this year. However, allowing them to influence your investment decisions is counterproductive.
Take raising interest rate fears. Many argue that rising rates decrease future earnings and whack stock valuations. While this may be true for some high-priced growth stocks, on the flip side, high rates benefit banks and financials. Similarly, the strong dollar has investors concerned that multinationals’ overseas sales are set to take a huge hit; conversely, foreign companies that earn income in dollars will see those translate to gains on their balance sheets. Other fears like sky-high energy prices amid ongoing Russian aggression in Ukraine have led to gas supply uncertainty in Europe, but directly benefit energy companies. Meanwhile, recession fears have helped consumer staple stocks such as Proctor & Gamble. Energy and consumer staples have been two of the best-performing sectors this year.
At Cardinal, we manage risk by strictly adhering to our methodology. We only invest in stocks that meet our quality and valuation criteria. In addition, we limit risk at the security sector and portfolio levels. Therefore, we focus on risk analytics in the portfolio construction process to ensure that individual securities, sectors, industries, and factors appropriately contribute to the portfolio’s risk-return profile. Our proprietary model is designed to help constantly monitor total risk exposures at multiple levels to ensure proper diversification and avoid taking unintended risks.
Our goal is to construct portfolios of high-quality companies that outperform the index over a full market cycle while mitigating downside risk. The companies we select for investment possess sustainable competitive advantages, capitalize on growth opportunities, and trade at a discount. These companies produce attractive risk-adjusted returns over a full market cycle. The portfolio’s quality bias and valuation discipline has contributed to the risk mitigation benefits.
We have a disciplined process that supports portfolio construction. The investment process is designed to narrow the universe from thousands of companies down to a handful of stocks that undergo rigorous fundamental analysis to determine those that best meet our investment criteria. Position sizes typically range from 1.0% to 3.0%, depending on the company’s size. The sell discipline is the reverse of the buy discipline. A stock that violates any of our investment criteria becomes a sell candidate.
Our philosophy reflects the belief that risk mitigation is critical to long-term investment success. We do not allow fear to drive our investment decisions, nor should you. Please call us if you want to learn more about our focus on your long-term investment success.