In striving for better performance, I often like to take a step back from the daily headlines to get a macro view of where we are and how far we’ve come year-to-date. As we enter the month of May, let’s check the pulse of the broad market indices as of 4.29.22 (source):
Dow Jones Industrial Average: -8.73
S&P 500: -12.92%
MSCI EAFE: -12.00%
MSCI Emerging Markets: -12.15%
US Aggregate Bond Index: -9.50%
As a quick and simple refresher, the Dow is comprised of 30, mainly value oriented stocks. The S&P 500 is 505 of large cap companies with an overweight towards growth stocks. The NASDAQ is mainly growth oriented stocks while the MSCI EAFE tracks international developed stocks and the MSCI Emerging Markets tracks emerging market stocks. Lastly, the US Aggregate Bond Index tracks the performance of the total US bond market.
Notice that the year-to-date performance is negative across the board, including fixed income. The only asset class that is positive in nominal terms is cash. However, due to inflation, the real return on cash is negative as well. By “real return,” I’m referring to the purchasing power of a $1, which no longer buys the same amount of goods and services it did at the beginning of the year and can be expressed as the nominal rate minus the inflation rate.
With signs of the year-over-year growth rate of inflation possibly peaking, a Federal Reserve on a continued path towards tightening economic conditions, persistent supply chain challenges, and what is turning into a prolonged war between Russia and the Ukraine, where is an investor to turn for better performance?
Before we answer that…
In my opinion, there’s two ways to look at the notion of better performance. The first is obvious: the return must have a plus sign in front of it. You essentially end with more money than you started with. The second way is less obvious. The return is better than a benchmark return even if it still has a negative sign in front of the number. Think of the latter way as a negative result but less negative than it would be had you invested differently. It goes without saying that we naturally prefer to have positive real returns. But in some short-term periods, that won’t be the case.
Here’s a current example of better performance in two negative returning asset classes (again, as of 4.29.22):
S&P 500 Growth Index: -20.00%
S&P 500 Value Index: -5.02%
In this example, the S&P 500 Value Index is outperforming its growth counterpart by +14.98% year-to-date. In the fourth pillar of our Investment Philosophy, we actively choose to structure evidence-based portfolios for our clients by overweighting certain asset classes. One component of this is choosing to hold higher weights in value stocks over growth stocks. This strategy is performing well in the current environment even if it’s still negative, albeit, less negative than it would be if we didn’t have conviction in our investment philosophy.
This takes us back to the question at hand, where does an investor turn for better performance during these times?
We believe there’s several ways to answer this question and it depends on your individual circumstances.
First, visit the strategy you’ve implemented and try not to sell for the sake of avoiding losses; analyze and understand why you own what you own first. We’re overweight value stocks while slightly underweight international and emerging market stocks. We also favor quality and cash-flow rich companies within the portfolio. It’s important to note that this doesn’t mean avoiding growth stocks altogether since there can be pockets of better performance within that asset class as well.
Second, as interest rates rise, bond durations should remain on the shorter end of the curve. This won’t prevent negative returns for bonds, but it should dampen the impact to bond prices as interest rates rise. Floating rate bonds can also be attractive depending on individual risk tolerance and capacity.
Third, defensive sectors like consumer staples, utilities, and commodities can be attractive tactical additions to a portfolio. In our opinion, these areas can complement an existing, well-diversified portfolio but shouldn’t be the largest weights in it.
Fourth, be methodical (purposeful) in allocating new cash to investments and during rebalancing periods. Just as we do each day for client portfolios, we look for long-term value and opportunities in where we allocate cash. This approach can also manifest itself through dollar cost averaging like participants do with each payroll deferral into their employer sponsored retirement plans.
There’s no doubt that economic challenges lay ahead. We cannot predict what tomorrow will bring but we also aren’t blind to the potential risks in front of us. We don’t believe anyone can accurately—and consistently—outguess the direction of markets. For this reason, we believe constructing evidence-based portfolios that align with your tolerance and capacity for risk, your financial goals, and preferences is a better means to a positive investment experience.
We aren’t the type of firm that markets on doom-n-gloom predictions. Rather, we work with clients to identify what doom-n-gloom may look like specific to their lifestyle. No two clients are alike. We then build and manage portfolios that we believe match certain characteristics so that our clients can tolerate what the world brings their way. If the past several months have been challenging for you, get in touch with us. We’d love to show you how we help clients to see if we’re the right fit for each other.
Image Credit: Marco Verch Professional Photographer