Market Update and Return from Vacation
Hello,
I’m excited to reconnect with you after a refreshing trip to New Brunswick, Canada. Over the past two weeks, I enjoyed swimming, cooking, kayaking, reading, and spending quality time with my family. I’ll share a few pictures below after the market commentary.
Market Commentary
The S&P 500 has declined by over 5% from its all-time high reached on July 16, 2024. Recent headlines attribute this sell-off to escalating conflicts in the Middle East and concerns that the Federal Reserve may not cut rates swiftly enough.
However, another critical factor could be the negative flows into passive index funds. The basic algorithm behind index investing—where fund managers buy stocks when funds flow in and sell when funds flow out—may be contributing to the market's downturn.
Fund manager and researcher Mike Green has long highlighted the changing structure of markets. When employees defer dollars into their Target Date funds in their 401(k)s, these dollars flow proportionately into the stocks that make up the index. This process works in reverse when funds are withdrawn, such as when employees retire or are laid off, or when Required Minimum Distributions (RMDs) increase.
Index funds typically hold very little cash, relying heavily on positive inflows to absorb selling pressure. This potential mismatch, reduced market elasticity, and other features of the indexing phenomenon can lead to particularly sharp sell-offs during negative flow periods.
Strategies for Navigating Market Volatility
There are several prudent strategies to manage these market episodes:
Hold an allocation to cash
Own assets with low correlation to stocks
Plan larger expenses ahead of time to avoid selling in a down market
What Happens Next?
The future market trajectory depends on several factors. If this downturn is merely a liquidity blip, we might see the selling pressure subside, with the indexing phenomenon resuming its upward push on stock prices.
However, if economic weakness and employment trends continue to deteriorate, a deeper correction could occur. In such a scenario, policymakers are likely to intervene if asset prices decline significantly and persistently. Drawing from the 2009 and 2020 playbooks, they might cut rates, buy bonds, and implement other liquidity measures to support asset prices.
These market dynamics underline why we build portfolios with a slice of cash, emphasize high-quality bonds, include assets like gold, and focus on structural resilience—such as becoming debt-free and maintaining an appropriate balance of risk and safety assets.
It's important to remember that policymakers are unlikely to let the financial system break down irreparably. They can use currency debasement as a pressure release valve, which supports asset prices over the long term. While there will be moments of negative flows and sharp corrections, assets that are relatively scarce, like global stocks, have good prospects for offsetting the effects of debasement over the long-run.
Moving Forward
Periods of uncertainty and volatility present opportunities for advisors to add value. If you have concerns about the markets, please reach out so we can discuss your situation. Rest assured, our collaborative efforts have taken into account the factors driving current market actions, and sticking to our existing strategy remains a sound approach.
Returning Home...
Please enjoy a couple of pictures from my time in beautiful, cool New Brunswick.
Cole, Annie and Kaylee at Lake Chamcook
A look out at the lake. The maple tree near the center of the image was damaged from high winter winds. I practiced my “V” notch and laid the primary trunk down for firewood processing.
Thank you for your continued trust and partnership.
Best regards,
Cole Brooks
