3 Defensive Moves to Make as a Growth Investor Today (1 Tip from Cathie Wood)

This is a shortened version of the original article originally posted on 1 Dec on financialavocado.com

It’s been a rocky few weeks in the stock market. As an active growth investor, my portfolio is a sea of red. Here is my analysis on the current market and 3 defensive moves I will take.

Trend 1: Rising Inflation – Cash Loses Value

First, where are we today in the market? There are 2 key trends to understand.

The purchasing power of the dollar over the past 76 years has declined by 94%. Meb Faber shows in his book Global Asset Allocation that what used to be a $1 can only get us 6 cents today.

This is the effect of typical inflation which is 3.3% on average annually (not much to do with QE yet based on this timeframe).

Hence we always hear how important it is to INVEST instead of leaving cash in the bank. By investing, we can better maintain the value of our hard-earned money.

Then Covid-19 happened. We saw incredible money supply increase as the Fed printed more money to stimulate the economy. See that vertical line in 2020? This further devalues cash.

How long will this continue without consequences? Already, the US reported its highest inflation jump to 6.2% since the 1990s.

Trend 2: Overvalued Stock Market – Risk in Equities

Although I believe in buy-and-hold, valuations do matter. The price you pay influences your future rate of return. Pay a below average price and you can reasonably expect an above average return, and vice versa.

CAPE Ratio, or the Cyclically Adjusted PE Ratio, is the PE ratio based on average inflation-adjusted earnings of the previous 10 years.

It smooths out fluctuation of company profits over different stages of the business cycle and tells us whether the market is overvalued or undervalued as a whole.

Ten-year CAPE Ratio vs. Future Returns, 1900-2014, Meb Faber

Faber’s chart shows that beyond CAPE of 25, median future real returns are 1-2%. Once CAPE ratios rise above 30, forecasted returns can be negative for the following ten years.

Guess where we are today? Yes it’s the red dot below.

S&P 500 CAPE Ratio, Source

So what can we do in this scenario?

1. Consider investing in some real assets i.e. gold, real estate (including REITs)

As a millennial born in the 90s, I was too young when the 2008 crisis happened for it to mean something to me. Many of us have only known the bull market in equities of the past decade. Hence generally, we are significantly overweight in growth equities and underweight in ‘traditional assets’.

Therefore, I believe as a growth investor, there is merit to look beyond the comfort zone and consider real assets.

Analyzing 8 asset allocation strategies of renowned investors, Faber found the best performers in the inflationary 1970s (not red in the second table) are those with a higher percentage of real assets.

Real assets in this study refer to TIPS, Commodities, Gold and REITs.

Source: Global Asset Allocation, Meb Faber

Note: Buffett’s strategy being studied is made of 90% stocks 10% bonds. In the absence of real assets, it performed the worst during the inflationary 1970s (other than the 100% stocks strategy).

Marc Faber’s Allocation Source: Global Asset Allocation, Meb Faber

The best performer during the inflationary 1970s (and actually, generally across different decades) is Marc Faber. This table shows his detailed portfolio allocation as a reference.

2. Reduce allocation to high growth equities

Correspondingly, I will slow down allocation to high growth equities like Tesla. Unless there is a correction of 10%, during which I may DCA slowly.

3. Invest in “cash-like innovation stocks”

This is a concept I caught from a CNBC article on Cathie Wood. Her ARK funds are not allowed to hold any cash, so she parks dollars in what she calls “cash-like innovation stocks”.

Since it is futile to time the market, rather than sitting on the side with cash that is eroding in value, her strategy is to rotate into defensive tech stocks. Examples include Google, Apple, Microsoft.

“During a period of volatility like we’ve just seen, we will sell those stocks and move into either our more pure-play or earlier-stage innovation companies that are being hurt by risk-off.”

When a big correction comes, they drop relatively less than other equities. When it is clear that the market is bouncing off and trending upwards, one can sell them to buy back into the high-growth stocks like Tesla.

If the crash never comes, they appreciate steadily or hold their value resiliently, helping us beat inflation.

What will I do?

I will do a combination of the 3:

1. Maintain Singapore REIT allocation of 25%
2. Reduce purchase of high-growth equities while investing extra cash in Microsoft and Google
3. DCA when S&P corrects 10% or market trend is reversing

It may seem like I am predicting the market direction, but I am not. I’m being cognizant of “where we are today” as Howard Marks said and adjusting my stance.

We decide what to wear based on what the weather looks like today. Similarly, I believe it is important to understand the basic macro economy as a growth investor and be flexible with our strategy. Even if it's pouring, it will not stop me from venturing out my house and enjoying life 🙂

Disclaimer: Financial Avocado is a personal investing blog of a millennial who is passionate about personal financial education. None of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money or your personal life.