Allocation Strategies for a Down Market

Between President Joe Biden's State of the Union Address and Fed Chair Jerome Powell testifying before the U.S. House Committee on Financial Services, there are multiple investing-related stories coming out of Washington, D.C.

In this podcast, Motley Fool analyst Bill Mann touches on what's been happening in D.C. and discusses:

• The current state of play for the oil & gas industry.
• Why investors should be looking at exploration and production companies.
• How the stock market has already priced in the first interest rate hike of 2022.
• The increasing lure of businesses with great free cash flow and the ability to raise prices.

Motley Fool analyst Jason Moser and Motley Fool contributor Matt Frankel share allocation advice for a down market.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on March 2, 2022.

Chris Hill: Check your politics at the door and put on your investing hat because it's not about red or blue. It's about green. Motley Fool money starts now.

I'm Chris Hill, joined once again by Motley Fool Senior Analyst, Bill Mann. Thanks for being back here by popular demand.

Bill Mann: I think it was just you and one other guy, though.

Chris Hill: That's popular demand. There are a couple of things I want to get to. As you and I are talking at the moment, the Federal Reserve Chair Jay Powell is across the river on Capitol Hill, spending some time with the nice people at the US House Committee on Financial Services. We will get to that. Long time listeners know this is not a political show. This is not the show for those who are looking to mix a lot of business and politics. However, I would be remiss if I didn't notice that the President of the United States gave the State of the Union Address last night, and one of the ripple effects of that speech is continued conversation of the oil and gas industry as the conflict continues with Russia's invasion of Ukraine. All of that laid out in front of you, where are we now with the oil and gas industry? What do you think as you watch the last 48 hours play out the way it has?

Bill Mann: It is interesting, and yet, we try not to be political, but sometimes politics shows up on business's door and this is absolutely one of those occasions. Chris, I think that we are in some ways seeing the result of a rather unserious energy policy here in the US and in Europe as well. It's the thing where a lot of the people who really track the energy industry have said was coming for a long time, have said that Europe, for example, was leaving itself way too vulnerable to Russia, for example, just for their energy needs. There's a cliche that energy is life. One of the things I was hoping for was to see a little bit more of a recognition of the fact. Even if we don't like it, even while the good person in me says that in time I want us to be a country that's run primarily on renewables, that we need to recognize now that our energy policy, as it pertains to the oil and gas industry, it doesn't help us at all, and it definitely helps our adversaries at this point, in particular, Russia.

Chris Hill: This is not specific to the oil and gas industry. This is the case with pretty much every industry that when there are overarching conversations in the media about a given industry, the attention goes to the biggest companies and the biggest names. The usual suspects in the oil and gas industry are companies like ExxonMobil and Chevron. Where else should we be looking as investors because this is an enormous industry. I chuckle every time someone refers to the healthcare industry, and I want to say, which part, because it's an enormous industry.

Bill Mann: It's like asking about business. Tell me what's your favorite business in the business sector?

Chris Hill: In terms of oil and gas, where else should we be looking beyond the usual suspects?

Bill Mann: I would look specifically in the exploration and production patch. One of the big issues that has happened is we've had about 10-15 years of deep underinvestment in exploration and production. In the US, there is a really neat measurement. It's called drilled but uncompleted wells. It's just it's a measure of how many wells are not producing right now but are ready? When we talk about turning on the taps, this is what you would talk about in terms of turning on the taps. In 2020, there were almost 9,000. Now there's about 4500. There really is not that much available ready to turn on taps in this country. So if you're looking at places where there is going to be an obvious demand, I would look at the exploration companies. Anadarko is one, and by the way, not a small company at all, $13 billion in annual revenue. Occidental Petroleum is another. These are companies that are out doing the exploration for, really, the fuel that's going to be running our economy, for a long while, whether we like it too or not.

Chris Hill: I want to go back to that metric because I've never heard of that before. Drilled but uncompleted wells, that's the metric?

Bill Mann: Yeah, D-U-C. Let's go acronym on everything, Chris. It's D-U-C. They're called drilled but uncompleted wells. If you have a Bloomberg connection or you have access to the EIA, the Energy Intelligence Agency, excuse me, those metrics are listed there. These are 95 percent complete. You could turn them on. The number that we have right now, both for energy policy and then also through the reality that following the drop in oil prices in 2020, there was a lot of losses in the oil and gas industry in terms of capital.

Chris Hill: Let's go to our friend, Jay Powell. I've been saying to you earlier today, I feel like the conversation that is taking place primarily on Wall Street about the Federal Reserve, and will it increase interest rates, if so, when? To me, it is like the financial version of a bad rom-com storyline where it's will they or won't they get together?

Bill Mann: Has Daphne noticed yet that Niles has a thing for her? [laughs]

Chris Hill: Start dating or don't start. That's where I am as an investor with interest rates like, "Hey, look. Raise them; don't raise them. Can we just move on?" That's when I'm being petty and childish. [laughs] When I become more serious, I think, let's assume, just for the sake of this conversation, that the way the tea leaves are reading right now come to fruition, and in mid-March, the Federal Reserve raises interest rates a quarter percent. In your opinion, then what happens?

Bill Mann: If you're talking about from the markets, as we record right now, it has already happened. The markets in the US are up strongly today. The S&P 500 is up about two percent.

Chris Hill: I'm sorry, just to interrupt, up strongly today because Powell's testimony came out. It was either his written testimony, or in answer to your question, he basically said, yes, this is where we're headed. You can draw a straight line [laughs] from when he made that comment to when the market started heading [inaudible 00:08:08] .

Bill Mann: Thank you for not presuming along with me that everyone has paid very close attention to this today. I guess it's really important to note that the market, really, is a discounting device. By discounting, it is really good at valuing in, right now, things that are known that will happen in the future. The fact that Chairman Powell came out and said that this was something that he believed was going to happen, it narrows the potential that there might be no interest rate increase, a Fed fund rate increase, or that there might be a larger one. In a time in which there is an awful lot of uncertainty given the geopolitical conditions that we find ourselves in, the fact that he went out and has put some boundaries around what it is that they're planning on doing, the market, I don't think will react then because it has already reacted today.

Chris Hill: Are there industries that become more or less attractive as a result of this?

Bill Mann: Not so much.

Chris Hill: Because just on the surface, Bill, a quarter percent isn't that much.

Bill Mann: No, especially from where we are. We are still at a multi-sensory low in interest rates. I think that the reason that interest rates ultimately go up and down is to guarantee an orderly operation of the economy. I would remain interested in the higher-quality companies that are generating lots and lots of free cash flow, the ones that have the ability to raise price, and be the ones that are financially in better shape and don't really need the debt. So companies like Google, let's go back to some of the old standbys, the largest most important companies in the world, Apple is another, these companies just really don't have much need for debt. They're cash-rich, and this gives them some more options.

Chris Hill: Just thinking about cash, you're not surprised that when Berkshire Hathaway came out with their latest quarterly report. You know what, I like the fact that they released it on a Friday afternoon. But given that this is what I do for a living, I don't actually appreciate it. [laughs] I would prefer they do it at a time when it's easier for me to talk about it. But I'm assuming you're not surprised that Buffett, and Munger, and their team just continue to stay as disciplined as possible. Because when you think about businesses that have billions and billions of dollars from the balance sheet, Berkshire Hathaway is right there. They're not doing anything really other than buying back their own stock.

Bill Mann: Yeah, and they came out in the letter, wherein Warren Buffett essentially said that they didn't find too many things outside of the ones that they are already owned to be that attractive. I think Warren Buffett and any company that has a lot of cash is just really, actually excited to see a point in time in which they are competing with less alternatives for acquisitions. I know that Buffett had mentioned in the letter this time that they are poised and ready to go, but they're not doing it yet. The fact that they have plenty of cash so much more than they need for the operations of Berkshire Hathaway, the business, and all of its subsidiaries, that speaks volumes for what it is, the type of environment that they may really thrive, and it's not one in which money is as easy as possible for anybody and everybody.

Chris Hill: Bill Mann, great talking to you, as always. Thanks for being here.

Bill Mann: Thank you, Chris.

Chris Hill: While the S&P 500 is up today, it is still down for the year, and we've talked before about the natural temptation to try and time the bottom. But since doing that is basically impossible, we wanted to share some allocation advice for the bottom of the market, referred down-market. Here's Matt Frankel and Jason Moser.

Matt Frankel: It's been quite a wild ride for investors lately, plenty of things going on around the world to keep the markets guessing. We're getting plenty of questions regarding how to think about portfolio allocation in a down-market. As we speak, right now, the S&P 500 is down almost 9 percent year-to-date. The Nasdaq is down about 12 percent. But there are some clear do's and don'ts that come with this territory. We wanted to take a few minutes today to talk about that. I guess first thing, really, what goes through your mind when we see market corrections like we've seen this year.

Jason Moser: Everyone always says I want to find cheap stocks to buy. That's what everyone wants to do. But I like to use it as an opportunity to get in on stocks that I may have missed out on, which there have been quite a few of those over the past couple of years. I complain to you for how long that I missed out on PayPal.

Matt Frankel: Yes, I remember that.

Jason Moser: So now I look at it as kind of a second chance to add stocks like that to my watchlist that maybe I missed the boat on the first time around, and now I'm being given a second chance, if that makes sense.

Matt Frankel: It makes perfect sense. I like that. I think we probably all have that list of stocks we feel like we missed the first time around. Honestly, we do try to combat that. You can feel like maybe you missed it, but by the same token, a good business is a good business, and I feel like I'd rather ultimately own that good business as opposed to just letting it go, even if I feel like the price ran away from me. But to your point, PayPal is a great example. We've seen PayPal, along with Block and other payments companies, really come back to earth here lately. So it's nice to see that you've got that company back on you. It sounds to me like, while it's easy to get a little bit worked up during volatile times, it can be easy to want to sell and run for the hills. Generally speaking, it feels like really you should be more excited about this, and I think you just keyed in on that. You're getting a chance, not only to perhaps revisit some companies that you feel like might have gotten away, but also probably add to some businesses that you already own, that you've maybe developed some more conviction along the way.

Matt Frankel: One mistake I see people making is trying to time things like they'll say, I don't want to buy PayPal now because it might go down more, which is definitely a valid point. I don't want to add to Block because it might go back down to the 80s, like it was a couple of weeks ago. Don't try to time things. It's always a good time to buy good businesses. You have to be willing to look like an idiot in the short run [laughs] if it makes you look like a genius in the long run. I'll give you a perfect example of that. Back in March 2020 when the COVID pandemic first started and there's tons of uncertainty in the market, you probably remember me saying I was buying Ryman Hospitality because it [inaudible 00:15:55] so badly. I ended up getting shares at about $14 a share, I think was my cost basis. It proceeded to go down another 20 percent, finally, bottoming it like $11. I looked like an idiot at that point. I timed it poorly. But today, it's trading for about $90 a share. So you have to be willing to get the timing issue out of your head because it's always possible that stocks could go down more. If the situation in Ukraine gets worse, I would expect pretty much every stock in the market to go down more with the exception of, maybe, oil stocks. You don't want to try to time it. They can always go down further. But it's always a good time to add good businesses for long-term investing.

Jason Moser: I like that and it really takes me back to something my father taught me when I was a teenager, when he was first teaching me about investing and just the entire the concept of it. He told me, first things first, he's, like, "Listen, when you buy a stock, you need to prepare for it to go down. It's going to be lower than what you paid for." He said, "You're never going to buy the bottom, and you're never going to sell the top, so just get used to that, and don't worry about it." He's right. It takes some going through the motions. It takes going through that to really become a believer. I think it's one thing for us to sit here and say it, but the benefit of going through times like these as an investor is it makes it easier the next time we go through them because the next time is inevitable. It's not a matter of "if". It's a matter of "when". I want to go to that market timing point that you were making because I think that's a really good one. 

We obviously talked about that a lot here at The Motley Fool, and that's not, I think, necessarily just our philosophy. I think a lot of folks out there believe in that as well, but it takes me to a study that I found recently at Bank of America, a study on the S&P 500 returns, and it broke down returns by decade going back to 1930. It looked at the returns over the course of the decade, but then it also took a closer look at if you excluded the worst 10 days per decade, if you excluded the 10 best days per decade, and then if you excluded the best and the worst 10 days per decade, and it was just interesting to me to see how profound an impact this can have on returns. So if you look at the decade from 2010-2020, the S&P returns were 190 percent. Now if you exclude the worst 10 days in that decade, your returns go to 351 percent. That sounds like a great deal. Maybe we should start focusing on trying to time the market if the returns are going to be that significantly better. The flipside of that coin is if you exclude the best 10 days per decade, your returns all of a sudden sink down to 95 percent. 

So you can see a profound impact on both sides of the coin there, and ultimately, this gets back to that point we're talking about a decade. What do you think the chances are of actually picking those 10 days in over the course of a decade. Trying to pick those ten days over the course of a month, I think would be [laughs] challenging enough to do it over the course of a decade, I think we all would agree it's impossible. You're not going to able to do it. There are additional costs that come with that. There are taxes that you would have to consider. There's opportunity cost of getting out potentially good ideas and into ideas that aren't necessarily as good. But I think the ultimate point here is that while the numbers can make people, perhaps, want to time the market, I think it's better to look at the bigger picture try to take this in a context and try to assess, what do you think the chances actually are of executing that timing perfectly, because I think you would agree, too, chances are pretty much zero.

Matt Frankel: Yes, one cannot. I've incorrectly called the bottom of February about 10 times. It's impossible to do, and I have said this feels like a bottom, probably about 10 times in February, so it's not possible to do, and you're more likely to lose out by being hesitant to pull the trigger than you are of gaining by trying to time the bottom.

Jason Moser: Now, how do you view because I know that we've seen, the Nasdaq, I think, growth stocks in particular, if it felt a little bit more pain here than in others. I know a lot of folks out there own a lot of these stocks and are probably feeling that pain along with us. How do you view allocation when it comes to stable companies versus those highflier growth stocks? Maybe they're not profitable yet, maybe they you got to look a little bit further down the road to really understand the potential there. But how do you view asset allocation when you're looking at those stable companies versus the unprofitable, riskier ideas?

Matt Frankel: One of the good parts of having a portfolio of boring banks and real estate stocks in normal times is it gives me a lot of wiggle room to pursue the growth opportunities when times [laughs] get rough. But that aside, I definitely think there needs to be some balance in your portfolio. If you've generally been a growth stock investor, and you're getting clobbered and stuff like that, maybe it's time to look at some high-quality real estate stocks that haven't been beaten down or high-quality bank stocks because those are starting to look very attractive right now because a lot of them have some [inaudible 00:21:20] exposure. So it could be a great time to try to find some long-term investments in an area you're not focused on, in addition to picking up shares in some of your favorite companies that you have been focused on. But there definitely needs to be some balance. There's opportunities on both sides.

Jason Moser: I tend to agree. I've said it before. I feel like if you can own one of those nice stable companies for every highflier that you own, I know in the near-term, it may not seem as sexy, maybe you're not really benefiting from the tailwinds of those growth stocks that you may be hoping for. But then, honestly, if you could own some of those stable companies, it really does make the investing journey much easier. It makes it really easy to sleep at night, and it makes it a lot easier to stomach the volatility that we see during times like these. I think there really is a lot of merit in trying to make sure that you're well-diversified and focusing on stability to go with that growth. It really does make investing, I think, a lot easier.

Matt Frankel: One of the great parts about being willing to attack investing from all different sides is I have not had a day where my entire portfolio is down. It just hasn't happened and that's because I diversify. I look for the best opportunities, regardless of growth value, what sector, things like that. There's always going to be a winner somewhere, and diversifying lets you find them.

Jason Moser: Why, I like that, Matt. I appreciate your insight today. I'm sure our listeners do, as well. Thanks so much for taking the time. It's good talking to you again.

Matt Frankel: Always good to be with you.

Chris Hill: That's all for today. But coming up tomorrow, we'll have three stocks to put on your watchlist for inflationary times. As always, people on the program may have interest in the stocks they talk about, and the Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow.