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Actively managing a portfolio of stocks, bonds and “alternatives” should help investors navigate the market’s latest bout of heightened volatility and position for better returns ahead. What are some of the ways that investors can navigate through the turmoil?
Broadly speaking, most of the market damage from this situation will likely be behind us in the coming days. Attention will now turn to the U.S. Federal Reserve and other central banks that were scheduled to begin raising rates in the coming months. The inflation picture, which was already a concern of almost all central bankers, has arguably been made worse by the events in Ukraine given the disruption to energy and agriculture and the sharp move in prices that has resulted so far from the invasion.
That doesn’t mean the U.S. Federal Reserve and the Bank of Canada won’t hike rates starting this month, but it takes a more aggressive approach off the table as they consider what this event has done to global growth – especially if higher energy and food prices start to squeeze out discretionary consumption.
The U.S. equity market endured its worst-performing January since the Global Financial Crisis in 2008. It should go without saying but corrections have always created new opportunities for investors in the past. Regardless of how big, every selloff culminates in a rebound that eventually pushes equity markets significantly higher than they were before the selloff. Think about it. As it stands today, the S&P 500 Index has officially corrected more than 10% twice in a little under two years and the first of those corrections – at the initial onset of the pandemic in the winter of 2020 – was a 30% drop in value, according to Bloomberg data. Yet, despite that, the index is up more than 30% from its high just before that bear market happened, which is better, on an annual basis, than the S&P 500’s long-term average of around 10%.
It’s only a matter of time then before the market rebounds from this most recent correction, but that doesn’t mean investors should just wait it out and do nothing. The more active they can be to mitigate losses during a period of heightened volatility, chances are the better off they’ll be. Same goes for investors who anticipate what types of opportunities lie in store once markets do bottom and begin rallying higher again.
By extension, asset allocation is hugely important right now. In an environment of rising interest rates, it’s probably not enough to rely on a 60/40 portfolio of publicly listed stocks and bonds without having a supplement of alternative strategies and asset classes that may provide a more reliable stream of uncorrelated returns.
In fact, while bond prices often rise when equity prices fall – and provide the necessary ballast that traditional 60/40 practitioners seek – that hasn’t been the case this time around, according to Bloomberg data. Based on a 5.6% decline in equities and a 2.2% loss in bonds, its namesake 60/40 index was down 4.6% in January, one of its worst performing months in recent years. As a result, an equity hedge like AGF’s anti-beta strategy may help offset some of these losses.
Asset allocation is only part of the equation. Some investors may also need to spend more time re-positioning within each of the main asset classes than might be the case in a less volatile climate. On the equity front, there has already been a substantial rotation out of long-duration growth stocks whose future earnings – if any – are highly susceptible to rising rates. And with many of these names now trading at much more reasonable valuations than they were heading into the year, that could set the stage for the inevitable rally higher.
Even so, the eventual upswing won’t likely be fueled by the same degree of speculation that has largely defined equity markets over the past two years. If anything, the “Spec Tech” trade that resulted in unreasonable valuations for many technology firms may be starting to give way to an emphasis on growth companies with quality characteristics like clean balance sheets, free cash flow, and strong earnings profiles that can withstand the rigors of tighter monetary and fiscal policy, leading to subdued economic activity. To that end, some of the most profitable big-tech names have been hit especially hard this earnings season because of unexpected earnings misses or weak guidance about their future profit growth, which has undermined the rich trading multiples they’ve amassed in recent years.
At the same time, value-oriented cyclical stocks should be considered in a similar vein. While they have outperformed their growth counterparts almost en masse so far this year, it is the higher-quality cyclical names that are likely to benefit more going forward. All in, investors need to be thoughtful about what types of companies they want to own given the heightened volatility that’s at play.
There may be some periods of relative calm in the weeks ahead, but it’s going to be tumultuous for as long as there are doubts about the plans of several central banks including the U.S. Federal Reserve to tighten monetary policy and ward off inflation. The biggest fear is that they will tank their respective economies by raising rates too aggressively. There are already signs that economic growth is beginning to wane in the United States, for instance, yet the market is predicting as many as eight increases this year and next.
Of course, the Fed hasn’t committed to that many increases. Its “dot plot” forecasts only three rate hikes this year and while one of those is almost definitely going to happen this month, some Fed officials have spoken cautiously in more recent days about what might come next because of the uncertain outlook for inflation and the ongoing pandemic. Then again, it’s partly this disconnect that makes investors so jittery.
And if that isn’t enough, it’s important to understand that the market isn’t just concerned about the Fed making a mistake regarding interest rates. It is also deeply worried about the prospects of a reduction in the U.S. central bank’s US$9 trillion balance sheet, which the Fed says it will start doing later this year yet has been short on details to date. Remember, the expansion of the Fed’s balance sheet through quantitative easing over the past decade has been a huge liquidity boost to the equity market and may be the single most important catalyst that has driven stocks higher throughout this period. Therefore, quantitative tightening could have the opposite effect and end up being a risk on par with a rise in interest rates that ends up being too aggressive.
If anything, then, there should be no doubt that equity markets will eventually rebound from the current correction and it still seems likely that they can end 2022 higher than they were to begin the year. But that doesn’t mean investors are necessarily through the worst of it.
Heightened market volatility is also here to stay, likely for as long as the threat of higher rates and the run-off of central bank balance sheets remains uncertain and their impact on future growth prospects is not fully understood.
Kevin McCreadie is Chief Executive Officer and Chief Investment Officer at AGF Management Ltd. He is a regular contributor to AGF Perspectives. Click to learn more about AGF’s fundamental, quantitative, and alternative investing capabilities.
Notes and Disclaimer
© 2022 by AGF Ltd. This article first appeared in AGF Perspectives. Reprinted with permission.
The commentaries contained herein are provided as a general source of information based on information available as of February 24, 2022, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Market conditions may change investment decisions arising from the use or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.
AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.
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