Our Thoughts on Recent Market Volatility
“The weirdest paradox in investing is that all past market crashes look like opportunities, but all future market crashes look like risks.”
By Scott Middleton, CFA, CIMA®
When you’re living through them, investment losses always feel like they’re only going to get worse.
Equity prices have fallen 10%? Surely 20% is next.
Stocks fell 20%? Well, a 30% bear is right around the corner.
Stocks fell 30%? Now it’s an all-out crash. Here come declines of 40%, 50%, 60%, etc.
Stock and bond prices have been driven lower in 2022 by soaring energy prices, the Russian-Ukrainian war, increasing interest rates, the highest inflation levels in 40 years, the rising potential for another recession, speculation gone awry, and an extensive list of other variables.
As of this writing (May 6), U.S. large cap stocks have fallen about 14% from their highs earlier this year, which is about a normal intra-year pullback (see Exhibit 1, next page). The decline in equities in early 2020 was two-and-a-half times worse than the pullback so far in 2022. Rising inflation has pushed the investment-grade bonds down about 10%; by some accounts, it’s the worst bond market since 1842. However, diversifying strategies, such as floating rate corporate loans, real assets, and real estate properties, are providing much-needed downside protection and better returns for portfolios.
On the economic front, corporate profit margins are strong, business surveys are in expansionary territory, and the U.S. unemployment rate is at 3.6%. Wages are moving up in part because there are an unprecedented 5.5 million more job openings nationwide than persons looking for work. While nominal GDP (real GDP plus inflation) rose at a robust 6.5% annual rate in Q1, real GDP declined at a 1.4% annual rate due to high inflation.
Looking Forward
The future is always uncertain. Stocks and other risky assets just might fall further from here. Or they may have bottomed out and will soar from here. The best long-term investors are process oriented. Alternatively, unsuccessful investors often make decisions based on predictions (either their own or from the latest investment guru) and not enough on process. If you know that stocks and other assets will go through good and bad cycles, it can be easier to adhere to a predetermined methodology to navigate through tough markets.
Time Horizon
An ongoing commitment to your investing time horizon can save you from making rash decisions based on negative news. Making ongoing portfolio decisions based on forecasts of short-term market moves is a recipe for disaster, as no one has ever consistently predicted market movements. Long-term investors know in advance that they will have to endure corrections, bear markets and crashes from time to time – as well as have their portfolios grow from being patient and disciplined.
Diversification
When you have a properly diversified portfolio, you will always own too little of what is performing well and too much of what is going down in value. The next big gain in your portfolio might come from a surprising place, because not all assets move in the same direction and with the same magnitude. However, the main way for diversification to work well is to have, and use, target allocations for each asset class in the portfolio.
Rebalancing
Having target asset allocations will not work if you don’t occasionally rebalance the portfolio back to your target weights. Rebalancing is a systematic way to add to assets that are depressed in price and trim them when they become relatively expensive. Innovest believes that the benefits of portfolio rebalancing include avoiding having too much in growth assets at market peaks, and too little exposure at market bottoms. Our disciplined approach includes rebalancing portfolios in times like these, not based on market or economic forecasts, but on our proven process.
Conclusion
Extremely good and extremely bad economic conditions rarely stay that way for long because supply and demand adapt in hard-to-predict ways. In the same way, financial markets have tended to move higher over time, rewarding investors according to their risk tolerance, patience, and adherence to a proven process. While no investment firms or individuals know what will happen next, we are confident that disciplined investors are the best positioned to be successful investors.