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  • Don't let bad news derail your financial plan.
  • A slowing economy could mean the Fed gets friendlier sooner than people think.

I could reel off a slate of examples demonstrating how bad this year's been for investors, but I won't. I'll save us the trouble and leave it at; it's been bad.

The problem with bad news is that repeating it over and over can do more harm than good.

Psychology says losing money hurts. In his book, Misbehaving, famed behavioral economist Richard Thaler concludes losing money hurts twice as bad as making money. He may be underestimating it based on my Twitter feed.

Indeed, it makes sense that pain hurts more than pleasure. We're human, after all. Our brains are hardwired to treat fear with a lot of respect. Our lives depend on it.

However, investing isn't like surviving in the wilderness. Battling a bear market may feel like life and death, but it's not the same as facing a real-life grizzly in the woods. But, of course, that logic doesn't seem to matter when it feels like a real-life game of whack-a-mole between 9:30 am and 4 pm every day.

This constant drubbing is increasing the risk that biases derail your financial journey.

For example, extrapolating the current environment into the future, or recency bias, could lead you to assume the economy will worsen and stocks will spiral downward forever.

That thinking, coupled with the pain you feel from losing money, could cause you to deviate from your financial plan, and as a result, you may find yourself tempted to sell blindly to stop the pain when you ought to be buying to take advantage of opportunities.

Since the media's mental meat grinder could be taking a toll on your psyche, let's focus on some good news, or as Top Stocks' Helene Meisler says, "green shoots."

What's bad is good?

We're all aware that everything costs more than it did last year. Inflation is high. And the Federal Reserve's told everybody it's going to hike rates until it declines.

The modeling of substantially higher rates is a big reason why stocks have fallen. Higher rates reduce the value of future earnings, and as a result, people become unwilling to pay high multiples (price to sales/price to earnings) for future profits.

That's already happening, though.

About half of the NASDAQ stocks have declined over 50%, and the S&P 500's price to earnings ratio has dropped to 16.4, below its 10-year 16.9 average. Of course, P/Es could go lower, but that's not the point. My point is everybody expects much higher rates, and as a result, they're positioning for them.

What happens if the Fed doesn't tighten as much as people think? Perhaps, the emerging risk is that people's expectations have gotten too hawkish.

Recent data suggests the Fed's plan may already be working. Over the past couple of weeks, we've gotten regional economic updates showing manufacturing and services activity is slowing. In today's Real Money column, Market Recon, Stephen Guilfoyle writes:

“On Tuesday, the S&P Global U.S. Manufacturing PMI flash for May printed at 57.5, still comfortably expansionary, but a three-month low nonetheless. The S&P Global U.S. Services PMI flash hit the tape at a less comfortably expansionary 53.5. This was a four-month low.

Both of these results fell short of expectations, the services number significantly so.

The Richmond Fed released its district-specific manufacturing survey results on Tuesday.

Richmond for those unaware is arguably considered to be the second most important regional manufacturing survey released in the U.S. behind only the similar survey released monthly by the Philadelphia Fed.

Last week, the Empire State (New York) Manufacturing Index printed in a deep state of contraction for May, followed by a Philly Fed that while not in contraction, badly disappointed at least at the headline. Richmond would follow suit.

In other words, three Federal Reserve regional districts have published their manufacturing survey results for May and all three badly missed.”

On the surface, you'd say that's bad news. But if you're hunting green shoots, you could say that evidence is starting to emerge showing the economy is slowing and if so, the Fed could wind up dovish sooner than people think.

Similarly, home sales also show significant slowing. Guilfoyle writes, "April had already been a poor month for Housing Starts, and Existing Home Sales as mortgage applications have plummeted. For the month of April, headline U.S. New Home Sales dropped 16.6% from March, while each and every U.S. region also printed in decline. Some areas that had been very hot, have now cooled significantly. The U.S. South printed down 19.8% from March. The South has now printed in decline for three consecutive months, as have the Midwest and West."

Higher mortgage rates slow home buying, easing home prices and reducing demand for related goods and services. Again, the data may make you worry about a recession, but the more likely a recession, the more likely the Fed can take its foot off the brakes.

Other evidence of slowing could soon be reflected in the data the Fed uses to make its decisions, too. For example, retailers are talking about being overstaffed (Walmart, Target, etc.), and technology companies are cutting back on hiring plans (Uber, Amazon, Facebook, etc.). So, unemployment could creep higher. 

Remember, the Fed's mandate is low inflation and low unemployment. So, suppose the economy is slowing, and as a result, inflation starts decelerating, and unemployment begins ticking higher. In that case, perhaps, the Fed pauses rate increases, allowing stocks to bottom.

Over the past two weeks, non-voting Atlanta Fed President Raphael Bostic laid the groundwork for precisely that scenario.

On Monday, he told reporters, "I have got a baseline view where for me I think a pause in September might make sense."

A glimmer of hope? A slight shift in Fed sentiment? Perhaps.

The Smart Play

Investors may be dipping their toes in the water, looking for high-quality stocks to add to portfolios.

On Wednesday, Top Stocks' technical expert Helene Meisler noted we're making fewer new lows than earlier this month, despite how 'painful' the market feels, writing, "The number of stocks making new lows on the New York Stock Exchange also now clocks in around one-third of what they were on May 11."

Meisler also mentions that bond yields are falling, and perhaps, that indicates bond markets think the Fed may wind up becoming friendlier. She writes:

“In the past two weeks, interest rates have come down from 3.1% to 2.76%. That must be why no one fusses over them anymore. Breaking 2.75% would be a minor lower low, but breaking 2.7% would be more than a minor lower low. My guess is if we get there, folks might decide to fuss that rates have finally backed off. Because right now, all we hear are cries for the Fed to hike more. Bonds seem to have a different view than market participants.”

The Fed's only beginning to unwind bonds on its balance sheet, but maybe, that's priced in? We'll have to wait and see. Regardless, it's worth knowing that the 20-year Treasury ETF,  (TLT) , which we recently called out as a bullish shift, also rallied in November 2018, before stocks put in their absolute low in that cycle in December.

What can you do? If you're a long-term investor regularly contributing to your retirement plans, increasing your contributions can position you for bigger gains exiting a bear market because you'll own more shares at a lower average cost.

Zooming out to look at the long-term chart of the S&P 500 can add confidence when you're feeling fearful, too. Yes, stocks can fall further (the NASDAQ fell over 50% in 08/09), but bear markets eventually set the stage for significant bull market rallies.

Don't fight the tape if you trade for a living or are a swing trader. As the saying goes, "the trend is your friend." The trend is down now, so cash is king, and margin is evil. If you want to buy stocks, focus on groups that are working, like energy, utilities, and healthcare, until the NASDAQ recovers its 21-day moving average. Then, you can dabble in growth stocks, using stops at significant supports to protect against a rollover to new lows.

Ultimately, all our buys and sells are driven by emotion. That's OK when you're executing a proactively developed plan, but it can be financially risky if you react to the day's market whims and whispers. So, plan trades and trade plans.

  • Don't let bad news derail your financial plan.
  • A slowing economy could mean the Fed gets friendlier sooner than people think.

I could reel off a slate of examples demonstrating how bad this year's been for investors, but I won't. I'll save us the trouble and leave it at; it's been bad.

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