Temporary stabilization measures

Genevieve Signoret

Letter from the President

(Leer la versión en español.)


  • I don’t know whether we’re experiencing a mere market correction or have entered a bear market.
  • I do not think the U.S. economy is entering a recession.
  • For clients whose investment horizons are 2-5 years, we’re working to stabilize portfolios by temporarily reducing exposure to stocks and buying very long term U.S. Treasury securities.
  • Once I have clarity, either we’ll reverse these trades (because I’ve decided that the bull market has resumed) or do something else (because I’ve decided that we’re now in a bear market, with or without recession).

Has the market topped?

When stocks start to sell off in the late stage of a bull market as they’re doing now, I’m forced to judge whether we’ve entered or are entering a bear market or instead are experiencing a mere correction. Since last summer, we’ve deemed each sell-off a correction and forecasted that the bull market would continue for another year or two. Now, however, I am very close to agnostic; I judge the probability that we’ve entered a bear market to be a whopping 45%.

Macro data is ambiguous too

My judgement call would be easier if I saw clear signs that the U.S. economy were moving into a recession. Bear markets don’t always announce recessions, but the reverse is true. You see, not only have I moved to the fence on the market outlook, I’m less certain than before as to my macro outlook also—I am only 55% certain that the U.S. expansion will continue.

At least correlations are negative

Happily, we’re experiencing “benign” or “normal” volatility, meaning that safe-haven asset classes such as U.S. Treasury securities, and risk assets such as stocks, display negative correlations (Treasuries move up in value when stock prices fall). This means that hedges we put in place to moderate losses during sell-offs—the classic one being long positions in long-term U.S. Treasury securities—work just fine.

Clearly, the bout of volatility we’re experiencing today is of the normal sort. Today’s market closes illustrate my point. Whereas SPY, the most popular S&P 500 index ETF, fell by 2.15%, safe haven TLT, the most popular long-term U.S. Treasury bond ETF, rose by 1.93%. Negative correlations are in at work.

Our hedge has worked…

Our current favorite way to hedge against stock sell-offs is to hold at least 80 % of any portfolio the investment horizon for which is less than ten in in 7–10-year U.S. Treasury securities. This asset class has trended up in value so far in 2016, proving its worth as a hedge against market panic.

…but we’re taking additional stabilization measures

But the panic has been so severe that today we took additional stabilization measures—temporary ones, for all clients investing over a horizon of five years or less: we’re lowering their exposure to the riskiest of equity subclasses and buying very long-term U.S. Treasury securities.

When will we exit?

Should we decide later that the bull market will in fact continue, once the sell-off has ended, we will reverse these trades, returning to our normal strategies.

If instead we decide that we’ve entered a bear market, we’ll consider revising those strategies.

How exactly we’ll revise will depend on whether the U.S. economy seems to be entering a recession or not.

What should clients do?

Buy. Ship your excess cash to your brokerage account so that once the coast is clear we can use it to seize up all the juicy buying opportunities.

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