Back to 1994
The last time the Fed hiked 0.75%. Been a while eh?
Nirvana released “MTV Unplugged” in 1994. What an album.
1994 was also the last time the Fed hiked rates 0.75%. I won’t spend time on this pontificating on what might happen. Companies today are different that companies back in 1994. Valuations are different (higher today in some firms, less in others).
The net Federal Funds rate is lower today than in 1994 (which was at >5% after the hike).
Inflation is much higher today than in 1994. A barrel of oil costs $100 now. It was about $17 in 1994. Stuff just costs more to ship around the world and that does have an impact on customer wallets.
My Bias towards Inaction
I have the privilege of being able to do nothing. As a young investor with a 15 year capital deployment cycle, I have another 12 years left to deploy capital. Paying higher prices for equities for the last 3 years hurts when valuations drop like a rock.
However, the sting gets taken out with new capital deployed in the subsequent bear market. The longer the bear market lasts, the better it is for driving portfolio cost basis lower and juicing IRRs during retirement.
As such, I am doing as little as possible. I will be limiting my actions to :
Lightly selling overvalued positions on strength and reallocating to beaten down higher conviction companies.
Adding new funds monthly to existing large positions
Starting new positions in companies i’ve been wanting to own but valuations were a tad too high - Microsoft is one such firm.
What I’ve Learnt so Far
I welcome bear markets since they present an opportunity to learn. Intellectually I understand that great stocks can devalue 90%, but experiencing that first hand with skin in the game is a different matter altogether.
I’ve summed up some stuff i’ve learnt so far :
Fast growing companies can get derailed by bad management and decelerate rapidly - Peloton is an example. The valuation is only justified by their 80% YoY growth. Take that away and the stock collapses. I took a small position in this firm with the intention of adding to it based on performance. A bet that hasn’t played out well so far.
Any company’s story can change rapidly - I’ve been a Facebook investor since 2017. It’s a company that’s made me a lot of money and lost me a lot of money (recently). The company’s trajectory and story has changed so rapidly in 2021 & 2022. It did take my by surprise. I remain an investor because of low valuation, strong balance sheet and large profits & cash flow.
Allocation matters - when a company’s story can change so rapidly, it makes sense to cap allocation no matter how juicy a company looks. I cap allocations based on 10% of total portfolio cost basis. This means that if I intend to deploy $1 million in 15 years, each position can never exceed $100,000 of cost basis. In the short run, this makes portfolio performance awful (Alibaba devaluing heavily doesn’t make for a nice annual performance for me), but I believe if a position is purchased at low valuations, the portfolio will perform well enough to fund retirement.
Trimming overvalued positions and allocating to undervalued ones may not be a bad idea - The idea of overvalued / undervalued is a tricky one, but assuming we know something is obviously overvalued can be useful. I purchased Shopify at $900 a share and sold it at $1300. I sold it when doing a valuation review of my portfolio. The funds raised from it was redeployed into Alibaba at HKD 190 a share. Not a great trade by any means, but not too bad overall since Shopify devalued to $330 and Alibaba devalued from HK$190 to HK$105 today. I hope to be lucky enough to make similar moves in future. My lessons here is that rotating to undervalued quality companies is a great defensive move. No guarantee against devaluation, but I stand a better chance of lower rates of devaluation and a good chance of capital appreciation (if it’s a quality business trading at low valuation).
What I am doing
I am actively acquiring shares in :
Alibaba (if it gets down to HK$70 again)
I would like to own Microsoft & Costco as well, but they cost too much at the moment. Costco is surprisingly expensive!
I will also begin an allocation to the S&P 500 index to round off my portfolio.
When the Fed hikes by 0.75% while inflation remains at over 8% and oil is at $100 / barrel, there’s a good chance for continue devaluation in equity prices. This should present (if I’m lucky) a 2 year opportunity to buy great companies at low prices.
Note : I am not a financial advisor and this is my personal portfolio. Do not blindly follow and do your due diligence. You can lose money by investing in the stock market. All my writing is opinion and NOT advice.