It's been a rough year for Wall Street and investors. Since the year began, the iconic Dow Jones Industrial Average (^DJI 1.56%), benchmark S&P 500 (^GSPC 1.52%), and growth-stock-dependent Nasdaq Composite (^IXIC 1.78%), have shed 9.5%, 13.5%, and 22.4% of their value, respectively, through this past weekend.
While the Dow and S&P 500 are officially in correction territory (i.e., more than 10% below their all-time closing highs), the Nasdaq is firmly entrenched in a bear market and closing in on a 25% loss in value over the past six months.
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Why is the Nasdaq in a bear market?
If you're looking for one simple answer as to why the Nasdaq is in a bear market, you're not going to get it. Rather, it's a confluence of factors that have Wall Street professionals and retail investors alike concerned.
For example, valuation has been an issue for the broader market for quite some time. The S&P 500's Shiller price-to-earnings (P/E) ratio -- a measure that takes into account average inflation-adjusted earnings from the previous 10 years -- has been above 30 for close to two years. Following the previous four instances where the S&P 500's Shiller P/E crested and held 30, the widely followed index subsequently lost at least 20% of its value. The growth-focused stocks in the Nasdaq have been among the loftiest-valued companies.
Margin debt is another very clear concern. As I've previously pointed out, there have only been three instances since the beginning of 1995 where margin debt outstanding has risen by 60% (or more) in a single year. It occurred right before the market was halved by the dot-com bubble, and just months before the financial crisis ultimately wiped away 57% of the S&P 500's value. It happened again in 2021. When margin usage increases rapidly, it's often a terrible sign for Wall Street.
The Federal Reserve deserves its share of "credit" as well. Even though no one ever said handling monetary policy for the largest economy in the world would be easy, it's clear in hindsight that the nation's central bank left its foot on the accelerator for far too long. For the first time in history, the Fed is raising rates into a plunging stock market. Wall Street loves historic precedence; and there simply isn't any in the current environment.
Let's add inflationary pressures, too. With inflation hitting a four-decade high in the U.S., and the price for a gallon of diesel hitting all-time highs, there's likely no near-term "fix" that'll stop the assault on consumers' wallets.
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I'm crushing the Nasdaq this year: Here's how I've done it
Despite seemingly everything going wrong for Wall Street, I've managed to increase the value of my portfolio in 2022. While I'm not talking about game-changing returns, I'll take a 1% year-to-date gain, including dividends, any day to the (22.4%) return for the Nasdaq Composite, through May 8, 2022.
How have I been so successful? I can tell you it has nothing to do with market timing. A majority of the 42 stocks I hold have been in my portfolio for between one and 10 years. Even if I could somewhat accurately guess when market downturns would strike (which, by the way, can't be done with any long-term accuracy), diving in and out of positions every 12 to 24 months would be burdensome and get old fast.
I'm also not up for the year due to short-selling. The 42 positions I'm holding are all long. Though I did execute one options trade this year that involved successfully selling an out-of-the-money call, the gain from that trade represents a very small percentage of my total portfolio value.
Rather, I attribute my positive returns in 2022 to the following three factors.
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1. Portfolio concentration
To start with, being concentrated in a few stocks and industries has helped. Precious metal mining companies (i.e., gold and silver stocks) account for 54% of my invested assets.
Since the beginning of the year, physical gold is higher by $58 an ounce, or about 3%. This isn't a jaw-dropping move, but it is par for the course during bear markets and steep corrections. Looking back 35 years, gold has significantly outperformed the major U.S. stock indexes during every big downturn.
I guess you could say I've taken a page out of Berkshire Hathaway (BRK.A 0.46%)(BRK.B 0.38%) CEO Warren Buffett's playbook. Despite Berkshire Hathaway holding roughly four dozen securities in its investment portfolio, just five of these stocks accounted for 73% of Buffett's $358 billion investment portfolio, as of last week. The Oracle of Omaha has long felt that diversification is only necessary if you don't know what you're doing.
When it comes to gold and silver stocks, I definitely understand the industry and feel comfortable with my long-term strategy.
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2. Dollar-cost averaging
Secondly, I'd attribute my outperformance in 2022 to simple dollar-cost averaging.
Dollar-cost averaging is the act of edging into a position over time so as to minimize risk and stress. Some investors choose to dollar-cost average into a position at very specific intervals (e.g., monthly, quarterly, or yearly), while others will add to their position when a certain share price is achieved or investment amount saved.
As for me, I generally dollar-cost average to the downside. This is to say that I rarely add to my position(s) at a higher price point than my cost basis. Sometimes that's a smart move, and other times I'm left kicking myself for not adding to a great a company.
I'm also a big fan of nibbling. Since most online brokerages did away with commission fees, I enjoy adding a little here and there to some of my favorite stocks during downturns. For instance, my largest holding was purchased on 26 separate occasions.
With the Nasdaq dipping into a bear market, dollar-cost averaging to the downside has been a worthwhile strategy. For some context, here are 10 stocks I've bought or added to in 2022.
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3. Hearty cash reserves
The third reason I've run circles around the Dow, S&P 500, and Nasdaq in 2022 has to do with my historically high cash position. Cash accounted for nearly 30% of my portfolio value, as of this past weekend.
During the March 2020 pandemic meltdown that saw the S&P 500 lose 34% of its value in just 33 calendar days, I threw every cent I had available, aside from my emergency fund, into over a dozen different stocks. But since the market rallied strongly between April 2020 and January 2022, and I'm not a big fan of dollar-cost averaging higher, my cash pile has been growing.
Additionally, I've pared down my largest holding -- a precious metal mining stock whose name I can't divulge due to disclosure rules -- by 21% since the year began since it had become such a large percentage of my portfolio. Doing so freed up a lot of capital that I've already been redeploying into new and existing holdings. Of the 43 trades I've made this year, eight were to pare down this top holding, and 33 were buys for new and existing holdings (I did say I was a nibbler!).
You could certainly say that maintaining a cash-rich portfolio emulates Warren Buffett. The Oracle of Omaha always ensures that Berkshire Hathaway has a healthy war chest at the ready to go shopping if the opportunity presents itself. Considering that the vast majority of corrections and bear markets don't last long, I plan to step up my buying activity very soon.
