What a difference a month can make. On the 19th of February, the Nasdaq index of US tech stocks closed at another all time high. It had risen 28% in the previous 12 months. By last Thursday, it was 13% lower than that peak. The broader S&P 500 fell 10% over the same period and the US small cap index, the Russell 2000, fell 13% (all three rallied strongly on Friday).
I won’t rehash the reasons why here. You can read plenty of that elsewhere. Suffice to say the “US exceptionalism” train has derailed.
The point of this post is what it means for our investors.
Well prepared portfolios
First, we have been preparing for the next downturn for the past year or so. It’s no secret that Forager’s performance hurt during the 2021/22 small-cap correction. These are concentrated portfolios of mostly smaller companies - you can expect some volatility. But we have the mandate flexibility to offer better downside protection than we did in the 2022 financial year, and we have been using that flexibility to better prepare our portfolios this time around.
The Forager International Shares Fund’s exposure to the US had fallen from 64.6% a year prior to 45.8% at the end of February this year. Its exposure to Japanese stocks has increased and the cash weighting for both portfolios was above 10% at the start of March.
That is not going to erase portfolio volatility. We still have significant investments in small companies like Catapult (ASX:CAT) and Nutex (Nasdaq:NUTX) that are vulnerable to a pullback after significant recent share price appreciation (we think the long-term prospects for both make the volatility well worth stomaching).
But the International Fund in particular is showing some nice resilience. As of Friday, the unit price was down 6.5% from its peak and less than 2% since the start of the calendar year. Our European and UK stocks have performed relatively well and the portfolio of Japanese tech companies is so far trading independently of what’s happening in the US. So far, so good, and we are turning our minds to how to make the most of the volatility.
Implications for the Real Economy
It is worth noting that this correction is not just driven by a change in investor sentiment. Trump’s erratic tariff measures represent the largest upheaval to global trade since the Second World War. It is going to have implications, something that businesses and consumers have worked out quickly. The University of Michigan’s survey of US consumer sentiment registered its lowest reading since September 2022 last week. Inflation expectations have jumped significantly. We are expecting economic activity to deteriorate rapidly in the US and are baking near-term recessionary conditions into our valuations. That is leading to wariness about economically sensitive US companies and even reducing the weighting of one particularly exposed Canadian manufacturing business.
Firing The First Bullets
There are opportunities emerging already, though. As in all corrections, the market reaction is not uniform and plenty of babies get thrown out with the bathwater. We have deployed some incremental capital into shares that have been unjustly treated. Flutter (LSE:FLTR) is a good international example of an opportunity to add back some of the money that has been taken off the table recently. And AMA (ASX:AMA) here in Australia traded back near last year’s lows on Friday, despite reporting a solid half year result and showing excellent signs of progress. We have added modestly to this investment and in total have deployed roughly a quarter of the Australian Fund’s cash since the start of the month. For the International Fund, it's been around one-sixth of the cash so far.
These are fairly modest portfolio changes and that’s reflective of the fact that this has mostly been an orderly market unwind. The most expensive parts of the market have been hit hardest.
Deploying Cash in a Downturn
Bear markets come in all shapes and sizes and there is no way of knowing in advance whether this is a 10% correction or the start of a 30% meltdown. Hence we have fired a couple of bullets and kept plenty in the chamber in case things get worse.
If you are waiting to deploy cash, a similar approach could be appropriate. Many of you have heard my thoughts on the damage investors do to their long-term returns by trying to time markets. The allure of cash should largely be ignored. Focus on getting your portfolio allocation right and stick with it through thick and thin. The Dollar Cost Averaging approach also works well when investing through markets in turmoil.
Many of you also continue to ignore me. If that’s you, consider adopting a similar strategy to us. My pessimism radar is nowhere near extreme yet. But there’s no guarantee it gets there. We have two portfolios of stocks we think offer healthy long-term returns and have been able to deploy some incremental capital in recent weeks. If your aim is to deploy more cash through the cycle, there’s nothing wrong with doing the same. If this is as bad as it gets, you have put a little money to work. If it gets much worse, you have plenty of your own bullets left to fire.