M.A.D. Market Strategy: Surviving the Economic Crossfire

📉 Mutually Assured Destruction: The Market's Dangerous Balancing Act 📈

Markets are on edge, and uncertainty is wreaking havoc on investors. In this episode of The Money Runner, David Nelson breaks down the concept of Mutually Assured Destruction (M.A.D.) — a strategy that’s now playing out in global markets. From rising tariffs to economic volatility, learn how to navigate the chaos, manage risk, and position your portfolio for what’s ahead.

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Transcript

0:03

Welcome to the pod, everyone. I'm David Nelson, your host. We have a lot on our plate this week. A lot of charts, an entire playbook to discuss. But first, if you were looking for the podcast the last couple of weeks, I had to take some time off. I had to pull back, cancel a lot of media network TV, had a focus on what was important, how to manage the volatility with the funds that I manage here at Bell Point. And no question, it's been a battle out there. But even in conventional warfare, eventually both sides need to regroup, maybe resupply. And maybe that's what's happening this weekend. Bulls and bears go to their respective corners and kind of rethink their strategies. Friday was the first day in weeks bulls have been able to stage something of a comeback, putting in one of its best return days since November last year. Even with that, the S&P 500 was down two and a quarter percent for the week. Look, I'm not going to sugarcoat it. Markets have taken a gut punch. However, this is less about the decline and more about how fast all this unfolded. We're talking COVID velocity here coming into this week. Large cap stocks are down about, what, 3.9% year to date, not the end of the world. But I think the velocity of this picked up really a couple of weeks ago. We saw Treasury Secretary Scott Bessen hit the airwaves, a lot of network interviews, kind of let the cat out of the bag when he said and I'm kind of paraphrasing here, we are not going to measure our success by returns in the stock market. They're willing to accept market volatility. They mean to change the trajectory of government spending and reshape the U.S. economy. Whether you are for or against this process, it is happening. And my job as a strategist and on the line portfolio manager is how to navigate this change and pilot the aircraft through the rough weather ahead when the market sniffs out the government's okay. Latest talks take a hit to fix a bigger economic problem. Uncertainty creeps in that uncertainty is kryptonite to risk assets. We hit our 10% correction. As of Thursday's close and right on cue, markets staged a comeback. The following day, reversion to the mean. It's a very powerful force. I'm a chartered market technician, a CMT. I'm not really a chart guy. You know, some traders live and breathe charts thinking the squiggly lines explain away everything. I'm not really in that camp, but sometimes a picture is worth a thousand words. If I go back three years and I'm choosing three years because this way we can include a bear market. In bull market combined, we can paint a linear regression line. That red line on the on that chart there with two standard deviation lines above and below. Right on cue, we hit the lower level. We get a relief rally on Friday. The trigger or excuse was Senate Minority Leader Chuck Schumer's decision to navigate some key procedural hurdles to let the C.R. or continuing resolution come to a vote. The C.R. passed and the president signed the bill over the weekend to fund the government for the next six months. This, of course, enraged progressives. That's another story. So is it over? Every talking head will tell you that market bottoms are prices. That's because the truth is we really don't know. The very fact that diversification is working for the first time in more than a decade should tell you a lot. In fact, it's a game changer. The volatility, that's a wake up call all in on stocks works when you're 30. But if you're north of 60, it is time to rethink that risk. The market is calling it for you. Answer the damn phone. Welcome to the Money Runner. I'm David Nelson. As a stock guy, I live for earnings growth and the macro view. Right now, the macro is flashing yellow. Recession odds are climbing, not a lock. But some pundits peg it at about 50%. That's actually worse than 100% because indecision paralyzes markets. Historically, markets price in a lot of recessions that never actually happen. It's the fear that triggers the sell off. Now there is some evidence to support raising the odds. The spread between investment grade bond yields and treasuries is starting to rise, not flashing red, but yellows fare. When does it end? It's usually value investors that step in first, often one security at a time. The good news is that we are seeing the first signs of that process unfold. Take a look at the performance of Nvidia on Thursday when the market was down 1.4%, ended the day in correction territory. Nvidia was down just $0.16. One look at the fundamentals shows why value players might be stepping into the shares in video trades at just 25 times earnings in a year, when revenue is expected to be up over 50% will be cheap at just half that growth. Let's look at the broad market for a similar analysis here. It gets a little more challenging, as you might expect. Valuations have come in right along with stock prices on Thursday's close. The blended p e ratio got to close to 20 times earnings very close to their bottom twice in the last year. And for the moment, the earnings expected on a blended basis are $275 for the S&P 500. As a reminder, blended earnings looks six months forward, six months backwards, so that $275 number holds. Then perhaps we have seen or within 5% of the bottom. But earlier I said the possibility of a recession is rising. And that, of course, that's the wild card. Let's take that $275 number and give it a 10% haircut, bringing potential earnings down to $243. Even if I'm generous and I give that a 20 times multiple, you get a 4860 or a little more than 13% lower than Friday's close. Look, these are what if scenarios and projections. And I'm not I'm not so arrogant to believe that these projections are gospel. I did this same analysis in March of 2009 and predicted the S&P 500 had another 15%. A downside? Well, of course, the rest is history. March was the bottom and the market never looked back. Diversification, let's be honest, for more than a decade, diversification has been a dirty word. It provided little protection and did little more than dilute your equity returns. The bear market of 2022 is a perfect example. Do the math. Let's use this diversified portfolio as a proxy 50% of U.S. stocks, 10% in international stocks, and 40% in bonds. At the end of 22, the S&P 500 was down over 18%. The MSCI index was down almost 14%. And in a year when you needed bonds to protect you, the aggregate bond index was down over 13% all in. What did you get for your diversified portfolio? You saved maybe just over 2% ended the year down over 15 and a half percent. That's only a little better than the all in stock guy over the next two years, the S&P 500 staged a massive recovery, leaping 57.8% on a total return basis. The diversified portfolio was up maybe 33%. International stocks were up less than half of the S&P 500. And bonds wait for it gave you an average annualized return of three and a half percent for the next two years. What's the point? Well, diversification is back. Don't sleep on international markets anymore. Europe's a standout thanks to the U.S. pushing the continent to shoulder more of its own defense and economic load. The DAX or the German index is breaking out of a multi-year funk and European defense stocks are soaring, some up 100%. In a flash ad in talk of winding down the Ukraine war and diversification beyond U.S. shores, it's paying off that same diversified portfolio from 2022 that did nothing for you in a bear market has kept most investors as close to the flat line. Year to date, mutually assured destruction met. That's the nuclear doctrine the world lives by. The same is being done with tariffs today. We can't discuss the recent market decline without discussing the role of tariffs or, to be more specific, the administration's efforts to increase tariffs across the board. In an effort to achieve reciprocity. The administration also looks to shift the burden of funding our government from taxing sweat to taxing companies that want access to the American consumer. The list of countries selling goods into the United States, paying tariffs that are significantly less than what they charge their U.S. counterparts selling the same products into their countries is long and well-documented. This administration is demanding reciprocity and seems prepared to go all in to get the job done. On average, the US charges a lot less in tariffs than its trading partners and additionally they look to use tariffs as a way to help shrink the deficit or at least keep it in check. A better barometer of the success or failure of this endeavor will be the bond market so far tell you yields are headed in the right direction, about 48 basis points lower since taking office. Here's where I come out. The truth rarely lives on the extreme. In the long run. Trade wars are counterproductive, but are sometimes necessary to force your trading partners to the negotiating table. Negotiations don't work unless the other side believes you are willing to push the nuclear button. I also believe that can be a role for tariffs shifting some of the burden of funding our government from the taxpayer to companies and countries that want access to our purchasing power can't bring a knife to a gunfight. Where I fault the president is the following while misdirection and chaotic negotiating strategy can work wonders against your opponent, it can disrupt businesses that want nothing more. But to understand the rules of the game, the president is negotiating in real time, thinking in days, weeks, maybe months. Business and industries have a different timetable and must think ahead. Five years or more, no one is going to invest capital in a project like reshoring, a factory back to the United States in an effort to avoid tariffs. If they believe two weeks from now that playbook is going to change, they're going to sit back and do nothing until there's clarity. That uncertainty is playing out in real time in markets each and every day. So where are we? I think we're in the early innings of a bottoming process. Last week's relief rally off oversold levels shows value buyers starting to dip their toes. It's price discovery where the big fish buy a reversion to the mean trade. Maybe that could push us back towards 5800 in the S&P 500. But don't expect a V-shaped recovery any time soon. Expect markets to retest. Thursday's low stabilization is going to take some time for you. It's reassessment time heavy in U.S. stocks. Diversification is not a dirty word anymore. Bonds and international stocks are pulling their weight. Stay sharp, not scared. Risk management is back in vogue. Like I said, the market's calling into the phone. That's a wrap for this week's Money Runner. You can dove deeper on my substack site dcnelson123@substack.com. I'm David Nelson and this is the Money Runner.