Assess, Plan, Implement
These are confusing times, to say the least. No one knows how this all will play out. It’s easy to get emotional. I’m hearing from many clients who are feeling high levels of distress. And yet well-diversified portfolios are not showing similarly high levels of disruption. Yes, we are experiencing market volatility, but the impact on portfolios is less it seems than investors might have expected. Should portfolios have matched the worst fears of investors? So far I think the answer is no. Should investors make adjustments? Maybe.
Assess After the elections, markets reacted with enthusiasm. The assumption it seems was that the group moving into Washington would be very business friendly and would cut taxes, slash regulation, and attack the deficit. Tariff talk was thought to be a negotiation tactic. Markets in the US surged on optimism about the potential of a policy repeat of this president’s first term.
But then in February things began to falter. The past month saw major indexes fall as many of last year’s most successful stocks came down dramatically. Investors began to wonder whether there is increased risk of recession. We had such a nice narrative of the potential soft landing for the economy, now there’s concern this is in jeopardy.
In my view, what we are seeing is a reset of expectations and a rotation among investments. This is very different from a wholesale selloff. Some stocks (e.g., large cap tech) are selling off dramatically, others are adjusting more moderately, some are rising (large value and international). Bonds are holding firm. Several other assets are growing (more on this later).
This looks like a policy-induced resetting of investment values rather than a systemic threat like the Great Financial Crisis or the first stage of the pandemic. The administration’s policies offer markets much to like and to fear. They are doing what they campaigned upon: reduce the size of government, reduce the deficit, bring jobs back from overseas to rebuild the American middle class. Deficit reduction and rebuilding the middle class are excellent long-term goals for the US. And these policies are potentially inflationary. Tariffs seem a blunt tool with high potential for adding to inflation and other unintended negative consequences. The potential impact of the various policies could go in a variety of directions: positive, negative, and possibly counterbalancing.
So Should Investors Panic?
I don’t think so. To be clear, despite the headlines, we are not currently in a recession. The economy and markets are still near all-time highs. Many economists are cutting their projections, but they are mostly expecting slower growth, not contraction (aka recession).
Bond markets don’t yet seem to be showing signs of significant fear. Randall W. Forsyth makes this point in this week’s Barron’s. While stock investors have been making significant moves, bond investors aren’t showing signs of panic. As I wrote in a prior essay, bond investors, mostly institutional, are a famously nervous and skeptical group. Their behavior, as indicated by moves in interest rates, tells an important story. At least for now they seem to be seeing things differently than investors in stocks.
Let’s remember that stocks have been famously overvalued for years. This was especially acute in large tech. Writers who pointed this out were seen as Cassandras as they warned that one day a catalyst would come to bring overvalued stocks back down to historic norms. While I could quibble about whether historical norms are the appropriate target, directionally the argument certainly seems correct. There are many such catalysts in play right now. What is happening may be part of an adjustment that was long overdue. Resetting values now might prevent a bubble later.
If You’re Worried, You Could Reallocateand Rebalance
If you feel you really need to do something, you could adjust your allocation. You could take a meaningful but not extreme step in dialing down your risk. For example, if your portfolio is 75% stocks and 25% conservative investments, maybe you should move to 60%/40%. Or move all the way to 50%/50%. Moves such as this are likely to reduce your downward risk. But recognize that this would also likely mute upward movement if/when markets rise. If reallocation enables you to persevere and not overreact, then it could be just the right move.
Next, within your allocation plan, check your level of diversification. Diversification works, especially in times like these. A well-diversified portfolio should already have exposure to different investment styles and geographic regions. In good times, diversification can feel like it holds you back. But what seems to hold you back in one market environment might be the thing that saves you in another. The rotation among stocks I referred to earlier (also related to reversion to the mean) shows flexibility in the flow of capital. Investors need to be flexible as well, and rebalancing how you are diversified can help.
Alternative Investments
For the foreseeable future,it seems likely that volatility will continue. We see this as potentially a good time to add alternative investments. We have recently made substantial moves to incorporate these investments into client portfolios. Used correctly, alternatives can help mute downside risk and smooth out the noise. We are interested in areas such as commodity funds that can follow a variety of trends (metals, agriculture, cattle, currencies, energy, etc.), muti strategy funds (that can apply a variety of strategies beyond long-term hold), and precious metals (gold and silver). There are many ways investors can put money into alternatives, including mutual funds. It is important to take care when deciding which alternatives to use and how much.
What Not To Do.
When stress is rising I often hear from clients some version of “let’s just get out of the markets until things settle down.” While this might seem appealing, I think it is practically unworkable. The problem is that by the time things seem to have settled down enough to go back in, the market may have already begun its recovery and they would likely have missed the sharp one day upward moves. Similarly, people say they want to sell out now and then go back in at market lows. Again, the idea is good in theory but can be very hard for actual investors. When markets are low, it is typical that the accompanying news is ominous, sentiment is terrible, trust is minimal, and hope for the future appears grim. Investors that are skittish now, near all-time market highs, seem like they’d be highly unlikely to invest when markets are in shambles. Better to be already in the markets before recovery begins.
Conclusion
If circumstances have you reeling, don’t make radical unalterable life changes. Instead, you could do something meaningful but not extreme. Take significant incremental steps that move you forward in the plan you’ve developed. You don’t need to implement it all at once, you can take weeks, months, or longer to put your full plan in place. Inaction is acceptable if that is in fact your plan. If you decide that you like your allocation and diversification, then it is okay to just let it all play out. Volatility doesn’t mean crash. A well-diversified portfolio, with a patient investor, should weather the storm.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Stock investing involves risk including loss of principal. Asset allocation does not ensure a profit or protect against a loss.