Investments

Managing Risk in the Markets

By Dean Barber

February 24, 2022

Managing Risk in the Markets


Key Points – Managing Risk in the Markets

  • Reviewing a Tumultuous January and February for the Markets
  • What Can We Expect from the Federal Reserve’s March 16 Meeting?
  • The Situation Between Russia and Ukraine Adds to the List of Unknowns
  • The Key Takeaway: Control What You Can Control When It Comes to Market Risk
  • 20 minutes to read | 38 minutes to listen

Between the Federal Reserve’s decision on rising interest rates and the situation with Russia and Ukraine, there are a lot of unknowns right now. Dean Barber and Bud Kasper discuss the importance of controlling what you can control by managing market risk to alleviate the angst of the unknowns.

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Show Resources:

Find links to the resources Dean and Bud mentioned on this episode below.


Market Madness

Dean Barber: Thanks so much to those who join us on America’s Wealth Management Show. I’m your host, Dean Barber, along with Bud Kasper. We are wrapping up a tumultuous February in the markets, which followed a tumultuous January in the markets. We’ve had two negative months in a row.

I think Bud and I need to share our feelings, thoughts, and research that we’ve done on really what’s happening with the stock market. I think this is one of those times where the stock market is unhinged from the economy and corporate earnings. The stock market is being driven far more on emotion right now than it is on fundamentals. We’ve seen this happen multiple times throughout our careers, so it’s not a surprise to us.

It’s never fun when the markets stop paying attention to fundamentals and start moving on emotion. It sometimes creates opportunities, but people can’t always find those opportunities because they become fearful and uncertain. They think, “Oh my gosh. Things are going to continue in a negative pattern. I’m going to run out of money. I’m not going to be able to do what I wanted to do.”

So, let’s start with Jerome Powell. We talked about Jerome Powell and walking the tight rope earlier in the year. In January, Bud and I predicted a positive year in the markets, but that there would be heightened volatility. And my goodness, we have seen the heightened volatility.

A 0.25% or a 0.5% Interest Rate Hike?

Bud Kasper: No doubt, Dean. I was thinking about what we’d talk about and what came to my mind was the correlation with COVID’s immediate impact on the markets. With COVID, the impact was because of disease. But there are multiple factors impacting the markets today. That ranges first and foremost with what’s going on with Russia and Ukraine to the actions of the Federal Reserve.

The Federal Reserve is meeting again on March 16. Most certainly we’re going to have at least 0.25% interest rate increase. There’s probably about a 35% chance that it will be a 0.5% increase. Last week, Logan DeGraeve and I discussed the Federal Reserve’s tactics in terms of how fast do they want to raise rates. I suggested that if the Federal Reserve is going to do 0.5% increase that they should do it at the beginning. If they do a 0.5% increase later in the year, that suggests that they should have started hikes earlier.

Dean Barber: Logan is a great CFP® professional. There’s no question about that. I remember that you said that they should’ve started raising rates in December.

Bud Kasper: December was my target for them to do something. I wish they had at this point. Esther George with the Kansas City Federal Reserve and Jim Bullard with the St. Louis Federal Reserve are leaning toward a 0.5% hike instead of 0.25%. We’ll see what happens, though. That is being debated among the committee members, which are generally the presidents. Not all presidents are represented but a good number of them are on the Federal Open Market Committee that makes the decision.

Dean Barber: Right. If they do a 50 basis points increase, that will shock the market.

Alleviating Angst by Managing Your Market Risk

Bud Kasper: A little bit, yeah. When you have the discussion of it in advance most maneuvering inside of portfolios is taking place right now or has already been done.

Dean Barber: If you look at the markets right now, they’ve probably priced in a total of a 1% increase in the Fed Funds Rate throughout 2022. Would you agree with that?

Bud Kasper: I think that’s fair. I’ve heard the possibility of as many as seven rate hikes, which would be overkill in my opinion. When you look at the facts associated with earnings on corporations, it’s strong. That’s the underlying foundation for us to think that the market has still some upside. Obviously, we’re still going through some angst right now, though. If you’re having difficulty with what the market is doing, then you need to manage your risk in the markets and make any necessary adjustments. It’s not a permanent decision.

Encouraging Developments with the Supply Chain

Dean Barber: Right. We’ll get into that, but let’s talk about the fact that corporate earnings are strong. There are clear signs now that the supply chain issue is beginning to loosen up. The shortage of shipping containers is dissipating and the cost of them has started to come down.

I think we’ve peaked on the inflationary pressures and we’re on the downhill side of it now. That’s another thing that I believe that the market is looking at. It doesn’t think inflation is going to be nearly as hot the rest of the year, the supply chains are loosening up, and corporate earnings are good. But if the Fed goes in and raises rates too fast, the fear is that we’ll have a hard landing and go into a recession. I think our economy is so robust right now that I don’t think a recession is on the horizon, but we’ve seen the Fed cause it before.

Bud Kasper: Yes, we have. The good thing about it is that history is behind us. We can read and understand that. Are there similar situations that we’ve had when there was a hard landing? How do we prevent that from happening?

Dean Barber: That’s right. It can be helpful to consult with a financial professional to ask them questions or mention any ideas that you might have. It’s important to control the things you can control in financial planning. Our Social Security Decisions Guide, Tax Reduction Strategies Guide, and Retirement Plan Checklist can all help with that.

There’s no doubt that there is a lot going on right now. We’ve already talked about the Federal Reserve and a little bit about Russia and Ukraine. We’ll get into that more later.

Quizzing Bud on Market Performances

More importantly, we want to share how a person or a couple should be looking at this in the context of their overall financial plan and their overall financial strategy. But before we do that, I want to have a little bit of fun quiz with Bud.

Bud Kasper: Great. Wait, let me put my seatbelt on.

Dean Barber: We know that just about every sector of the market is in negative territory year-to-date. There is one sector of the market that is positive year-to-date. Which sector is that?

Bud Kasper: Oil.

Dean Barber: Yes, it’s energy, which is up 20.63%. You’re probably going to get this next one. What’s the best performing sector over the last 12 months?

Bud Kasper: I’d still say technology.

Dean Barber: Nope, it’s oil. Energy is up 40% over the last month and up 45.89% over the last six months.

Bud Kasper: Not calendar year?

How Is the S&P 500 Looking?

Dean Barber: No, we’re talking 12 months trailing here. The S&P 500 is made up of 500 stocks. That’s why it’s called the S&P 500.

Bud Kasper: Clever.

Dean Barber: We have a program that will rank each one of those stocks either bullish, neutral, or bearish. How many of those stocks and the S&P 500 are currently ranked as bearish?

Bud Kasper: Out of the whole market? I don’t know. Half?

Dean Barber: 61. Only 61 stocks out of the S&P 500 are currently showing as bearish. Eighty-two are bullish, while the other 355 are showing as neutral. That gives the overall S&P 500 a neutral plus rating. Which isn’t something to say, “Oh my gosh. We have a horrible market. A bear market is coming. It’s leaking over into everything.”

Now, if you want to talk about communications, the sector XLC, there are 23 stocks in that. Sixteen of them are neutral, while the other seven are negative. It has a bearish signal at this point. But if you come up to what’s looking the best, it’s consumer staples and energy.

Bud Kasper: That makes sense. Those are things that people need every day

Dean Barber: Right. And financials are number two over the last 12 months as far as total performance. That’s trailing to about 19.5%.

How to Go About Managing Risk in the Markets

Bud Kasper: Remember, when the Fed starts raising rates, banks get to charge more money. That’s why they are a relatively stable type of investment in these times.

Dean Barber: Right. I think what’s very interesting in what people need to understand with the S&P 500 is that you’re going to have a portion of each one of these different sectors. When you start getting most of the stocks in these sectors that are showing bearish tendencies, that’s when you need to start getting nervous. That’s when you need to start taking some market risk off the table.

Right now, everyone should be asking themselves, “Am I uncomfortable with what’s happening? Am I losing sleep or wondering if this is going to destroy my ability to retire? Or is it going to destroy my ability to have the income that I need while I’m retired?”

Going Back to Your Financial Plan

You need to go back to what the financial plan tells you. It’s critical to complete a very comprehensive financial plan like we use with the Guided Retirement System. If you haven’t done that, you’re flying blind. When your read headlines like with Putin is doing in Ukraine, the Federal Reserve’s plans for raising interest rates, and now both are driving the markets wild, you’re going to act on emotion. You don’t want to do that in times like this.

Bud Kasper: That’s why we’ve said many times to get a second opinion. Let us have an opportunity to have a discussion with you about it and see where your comfort level is with market risk and if you still feel that you’re on the right path. Otherwise, find out what your alternatives are.

Those discussions are fun for me. People realize that I’m supposed to be the answer man. Even though we probably can answer most of their questions, it’s nice to have a discussion of why they reached out to us to begin with because there had to be some motivating factor.

Once we get into that, people usually open up and talk about their investments. They talk about their lives and how they’re trying to think about retirement. It’s understandable to be concerned about that and feel a little bit overexposed to market risk. Using a comprehensive financial planning approach can tell you exactly what kind of market risk you have in your portfolio. If you’re not comfortable with that, then most certainly let’s make some adjustments for you.

Dean Barber: I think of it as a sounding board and getting a second opinion so you can ask your questions.

The Economy Is Still Strong

Bud Kasper: It really is fun when people call in just to have a candid conversation about them. Well, let’s get back to what we were talking about before. That’s the March 16 meeting for the Federal Reserve. All eyes are going to be on Jerome Powell to see how the committee’s going to vote. Based upon my observations of what Powell has said in the past concerning what the committee’s been talking about, I believe it’s only going to be a 0.25% rate increase.

Dean Barber: That’s my feeling as well.

Bud Kasper: I think the underpinning of the economy is still sound. We feel that most corporations’ earnings are strong and anticipate them to remain strong regardless of the financial conditions we find ourselves in.

Dean Barber: Right. Even back in November, we talked about slowing growth being in our future. In other words, the rate of growth in the economy and the rate of growth in corporate earnings will still be strong, but it’s a slowing growth. It won’t be as robust as what we saw coming out of the COVID outbreak in 2020 and lasted all through 2021.

The Biggest Caveat: Geopolitical Uncertainty

And as we talked about before, the supply chain is loosening up. We’re getting things to places where they need to be. I believe that inflation has peaked and will begin to slow down along with the slowing growth of the economy, but the big caveat is … I’ll call it the Putin virus.

Bud Kasper: I call it geopolitical uncertainty.

Dean Barber: Did you get that? The Putin virus.

Bud Kasper: You’re so clever.

Dean Barber: You’re messing up everything.

Bud Kasper: Just to throw some lingo out there, people are going to say, “The Federal Reserve is becoming hawkish.” What does that mean? It means that they’re going to start raising rates. If they’re dovish, they’re going the other direction. When you start hearing these terms being tossed around, don’t make them foreign to you. Just embrace them for what they are.

A History Lesson on Interest Rates

Dean Barber: Let’s understand the purpose of the Fed raising rates to fight off inflation. To do that, we could take a walk down memory lane and revisit our old friend, Paul Volcker, from the early 1980s. At that time, we had that super inflation era of the Carter administration. Volcker jacked up that interest rate to like 14%, 15%.

Bud Kasper: A little lower than that, but yeah, it was nasty.

Dean Barber: You could get 10-year CDs at 14% or 15%. Can you imagine that?

Bud Kasper: And your mortgage rates were around 12%. People were saying, “I can’t afford this house.”

How Rising Interest Rates Could Impact the Housing Market

Dean Barber: That is a great point that you bring up, Bud, because rising rates will affect housing prices. There could be some people that overpaid for their home over the last couple of years. If we get mortgage rates back up in the 5% to 5.5% range, those houses won’t be able to sustain that value. They won’t be able to sell it for what it was because one of the things that was really driving housing prices was the ultra-low interest rates. People could afford a bigger home or afford to pay more for the home because their payment was still lower because of the ultra-low rates.

Bud Kasper: Well said. I’ve made that statement so many times that I’ve got it memorized. That’s exactly right. I expect housing prices to come down in the next 12 to 24 months as interest rates rise.

Dean Barber: So, if you’re thinking about buying right now, maybe you ought to ask us about it.

More Pain on the Way at the Pump?

Bud Kasper: Speaking of rising interest rates, we’re almost less than 10 trading days away before hearing the results of the Federal Reserve’s March 16 meeting. As investors, should we be focused on that? Is that something that is so important that I need to pay strict attention to that? I think it is. It’s going to have an impact on a lot of different things.

I was reading a piece the other day from a guy who I have a great deal of respect for. He said that investment cycles pause or even end when economic expansions are largely complete. We get an exogenous, usually political, or geopolitical shock that pushes energy prices higher. This has been the playbook for every significant pullback in global equity since 1973. Even the start of the financial crisis, which was not a geopolitical event, coincided with oil prices at $120 a barrel.

Dean Barber: Fascinating. Well, we know that if Russia does what everybody is anticipating they will do, we’ll get oil at that price again.

When Pipelines and Politics Clash

Bud Kasper: I filled up at the pump on Tuesday for $3.54 a gallon premium. These prices at the pump are hurting people. I believe that the markets are going to force us to do and undo things that have happened since Biden took office. I’m not trying to be overly political, but it’s hard not to ignore the impact of the Keystone Pipeline being shut down. We were a nation that was finally energy independent for the first time in generations. We were exporting oil, but now we’re importing it at a big clip.

And by the way, look at Germany’s situation. I’m ashamed of them for not stepping up to the plate, but they’re handcuffed because out of the XL pipeline. Forty percent of their energy is coming through that thing. If the sanctions come in and they shut down that pipeline, what’s your alternative going to be? They’re going to have to go to Saudi Arabia for oil.

I want to bring up one final point and that is on natural gas. We have 100 years’ worth of gas in the United States. Most of it probably comes from Hollywood. We ship out a lot of that overseas. The alternative ought to be that you can push a button and shift to like 30% natural gas and use oil that we’re producing or taking out because of the shelling process. You know what we need.

The Market Risk Is Real

Dean Barber: Bud, I want you to read that statement again by that individual who wrote this about the oil prices.

Bud Kasper: Investment cycles pause or even end when economic expansions are largely complete.

Dean Barber: OK. Let’s ask a question. Is our expansion largely complete?

Bud Kasper: I would say it’s probably 80% complete. And we get an exogenous, which means outside, usually geopolitical shock that pushes energy prices higher.

Dean Barber: Russia, Ukraine.

Bud Kasper: Right. This has been the playbook for every significant poll back in global equity since 1973, even the start of the financial crisis, which was not a geopolitical event, coincided with oil prices at $120 a barrel.

Dean Barber: So, that says that the market risk is real. Now, there’s no way to know for sure. Nobody has a crystal ball that says, “Yeah. This is over. We’re going to have a bear market. We’re going to have a recession.” Nobody is saying any of that.

What Does Your Money Need to Do for You?

Bud and I mentioned in January that if you made good money in 2020 and 2021, you’re probably still OK. You’re probably still up significantly over the last 26 months. If that’s the case, you need to reexamine your portfolio holdings and market risk. Even with getting a negative market return this year, we’re still way up from where we were 26 months ago. So, should you be taking some market risk off the table right now considering everything that’s going on? It doesn’t mean it’s all in or all out, but should you be reducing the market risk?

The question is, what does your money need to do for you? Many people who we’ve worked with or are familiar with us know that we use what’s called a Personal Return Index. Once we complete your financial plan using our Guided Retirement System, we can tell you what your plan—your money—needs to do. What is the return that you need to accomplish your objectives? That’s your PRI. Then, the ultimate question that can be answered is, what is the right portfolio mix through all economic cycles to allow you to get that return with the very least amount of market risk possible?

That’s why I said that you need to come back to that plan right now because there are a lot of things that are up in the air rightt now. Market risk with all the volatility is out there. Bud and I were just talking about one guy who thinks we’re going to have a 40% melt up followed by an 80% crash in the market within the next 12 months. You’re going to hear all kinds of crazy things, but bring it back to your own personal situation to mitigate that market risk.

Harvesting Gains Makes Perfect Sense As a Solution to Managing Market Risk

Bud Kasper: Yeah. And you have always said to harvest your gains and put them in a safe place for events like we’re talking about right now. That’s how you manage market risk. It makes perfect sense, doesn’t it?

Dean Barber: Absolutely it does.

Bud Kasper: Especially for retirees because we know you need to have the income. We can’t go in and wholesale the portfolio to accomplish that. All this is part of vetting through this very important information during the comprehensive financial planning process that we provide as a firm.

Dean Barber: I know we’re raising questions in your mind right now. We want to make sure you get those questions answered. We’re happy to answer any of your financial questions, whether they have to do with investments, taxes, estate planning, risk management, real estate—whatever they may be.

What Can We Expect from Bonds?

Bud Kasper: I think a good segue to finish this discussion is to focus on bonds. Bonds have been the anchor of so many portfolios, but we’re sort of going through a bear market in bonds.

Dean Barber: First, let’s clarify this. Bonds have always been and always will be a stay-rich investment. You just need to understand what you’re buying. If you buy an individual bond today at a certain price and hold it to maturity at whatever its duration is, and it pays the interest rate, you’re going to know exactly what your return is going to be over that period.

If you try to sell the bond in between time, that’s when you can start to see the value of that bond change. But every bond, especially individual bonds should be looked at just like a CD. If you look at high-quality bonds, you know what you’re going to pay, how much interest you will get, and exactly how much going to get back so you can calculate your rate of return. But there is risk in bonds right now. I don’t disagree with you, but not all bonds are created equal.

The Last 26 Months of Returns Have Been a Gift

Let’s look back again over the last 26 months and recall what an amazing run we had despite the COVID hiccup in March 2020. Don’t forget what your portfolio has done. Even though we’re seeing pressure on the markets to begin 2022, most people that held equity positions over that period should be in good shape. They should have had nice double-digit returns over that time. Even on a 60/40 portfolio, you should have been averaging at least 12% a year over the last 26 months.

Bud Kasper: I would say so. Yes.

Dean Barber: When you think about that, that’s been a gift. Now, let’s take some of those gains. For example, let’s say you’re retired and need to spend 4% per year off your portfolio. If you just made 24% over the last two years, you’ve got six years’ worth of spending.

Take that six years’ worth of spending and set it aside in something very safe so that you can the treat rest of my investments like you’re six years younger. Those are strategies that you should be employing.

The safe spot to normally be in would be bonds. We mentioned earlier how bonds have been struggling, but not all bonds are created equal. Bud, what’s on your mind with bonds?

Bonds Are Difficult Right Now

Bud Kasper: Well, I had a lengthy discussion last week with our committee and another company. There is a person with that company who I have a great deal of respect for. They’re candid in nature in terms of how they talk about the bond market.

Just to cut to the chase, bonds are very difficult right now. Even in the difficulty that I am talking about with negative returns as opposed to positive returns, every person out there believes that when the market is going down, that the bond market is going up. While there is a large percentage of time where that’s true, it is not true this time. Right now, they are not very encouraged about where the bond market is going to be in terms of total return.

You will always get the interest that is being represented by product, by the investment itself. However, the fluctuation in price, which will impact the principle value of your investment, has been under pressure. They think it will continue for a little bit.

Thinking of Bonds and Interest Rates Like a Teeter-Totter

Dean Barber: All right. So, let’s break this down by going back to the time when you were a young child. You’re on the playground and playing on the teeter-totter with one of your friends. Let’s pretend that you are interest rates and your friends are bonds. You’re on the ground, which is where interest rates are today. Your friend, the value of bonds is way up in the air. As soon as you start to go up, your friend starts to go down.

Right now, most bonds that you want to purchase today or that you already own today are trading at a premium. A bond matures at its par value, which is generally $100. Today, most bonds are being priced anywhere from about $125 down to $110. So, those bonds are valued well above what they’re going to mature at because interest rates are so low.

As interest rates rise, those bonds will come back down to that maturity value. That’s what Bud is talking about. He’s saying that rates will go up. We know that and the writing is on the wall. The premium that we have in those bonds today can be lost.

Looking for Alternative Bond Options

So, the question becomes, are there bonds I can buy? Are there alternatives in the fixed income space that I can buy at par value or at a discount to par value? The answer to that is, yes, there are. You need to look since it’s not something that’s just simple to do. But there are still good opportunities in the fixed income segment. You just need to look beyond just the AGG, which is the bond aggregate and be more selective.

Bud Kasper: Very much so. And for those who are not aware, when Dean says par, he means $1,000 for $1,000. Dean is right, but in the broader sense of what the aggregate is doing, it’s a negative territory. With the stock market going down and the AGG going down simultaneously, we’ve had more volatility if you’re associated with a 60/40 portfolio.

Dean Barber: Right. But I want to make a comment because you said people believe that when stocks go down, bonds go up. Let’s remember that we are in a 30-year bull run for bonds because we’ve been in a 30-year declining interest rate environment. Go back to the early 1980s when Volcker raised rates up to the moon. They’ve been steadily coming down for three decades now.

As those interest rates have been falling, the bond values have been elevated. That created a great run for bonds. There’s no way in our wildest dreams that we can imagine that bonds will do the same thing over the next three decades.

It’s Time to Start Saving

Bud Kasper: I agree with that. The telltale evidence of that is what Dean talked about before, and that’s housing. When you have interest rates that low, it means you can buy a lot more house than you could when interest rates are like 3% greater than where they are currently. As the Federal Reserve starts to make their move, interest rates are going to rise, and that opportunity for low interest rate loans is going to go away.

That tells me that you better start saving some more money. You’re going to be better off putting down more principle and only have a loan amount that is reasonable based upon your budget.

Quiz Time for Dean

Now, I want to turn the tables and quiz Dean. What do you think the odds are of the Federal Reserve doing a 0.5% rate increase following their March 16 meeting.

Dean Barber: 25%.

Bud Kasper: Twenty-two percent. I’ve him on the hot seat now. At the June 15 meeting, the futures have the odds at 44% that it’ll be 1% to 1.25%. Who knows where they’re going to be by the end of the year, but I would anticipate three to four hikes.

Dean Barber: Three to four hikes at 0.25% each. So, that would be anywhere from 0.75% to 1% on the Fed funds rate by year’s end.

Bud Kasper: Exactly.

Dean Barber: That’s what I thought, but I still think that we’re going to start to see inflation slow down. I think the supply chain is going to loosen up more. I think that we still wind up at the end of the year with the 10-year treasury hovering around 2%. That means a flattening of the yield curve, but then there’s the Russia conflict. That’s a big unknown and there are always unknowns.

Staying Diligent with Your Financial Plan in Stressful Times

The point is that you need to stay diligent with your strategy. You need to make sure that your strategy from an investment perspective fits into your overall financial plan. If you’re going to make sure that your strategy fits into your overall financial plan, that means you need to have a financial plan that is a living breathing plan.

I know that there’s a lot of things going on right now. We’re here to help you navigate through all that. Even if you’re not a client of ours, you can schedule a 20-minute, ask anything session or complimentary consultation with one of our CERTIFIED FINANCIAL PLANNER™ professionals. You can just set up a phone call, Zoom meeting, or you can meet with us in person. Most people have been doing just a quick phone call.

Controlling What You Can Control

In times like this, it’s important to step back and control the things that you can control. You can control the amount of market risk that’s in your portfolio. You can control your taxes to a high degree by doing tax planning. The same thing goes for controlling your income stream by maximizing Social Security and understanding the different fixed income sectors. There are a lot of things that are within your control.

What’s happening with the Federal Reserve and between Russia and Ukraine are beyond your control. So, focus on the things that you can control.

Bud Kasper: I think the best word out there for people is confidence. If you don’t have confidence in what you’re doing or if you’re questioning whether you’re correctly positioned at this time, call us. Let’s have a discussion.

Dean Barber: Thanks for joining us on America’s Wealth Management Show. I am Dean Barber, along with Bud Kasper. I hope you enjoyed our program, stay healthy, stay safe. We’ll be back with you next week. Same time, same place.


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The views expressed represent the opinion of Barber Financial Group an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Barber Financial Group does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.