“Patience is the key of joy; but haste is the key to sorrow.” – Arabic Proverb
Years ago, when I worked as a market maker trading US Government Bonds and Interest Rate Swaps for a primary dealer our job was to be reactive to incoming news, economic developments, and client flows. We ran large leveraged trading portfolios and our number one function was to provide liquidity to our institutional clients whenever requested. Getting caught on the wrong side of a price move was a daily occurrence and always stressful. Generally speaking, when markets traded higher, we were forced buyers and when markets traded lower, we sold.
Today, I manage money in separate accounts for families, individuals, non-profits, etc. Our client base has a long-term focus and does not utilize leverage. This long-term focus enables us to build portfolios which match our clients’ return objectives, without getting too caught up in becoming reactive to daily news headlines. In times like today this is easier said than done.
The financial website Seeking Alpha recently sent out a table of long term returns to their readers which is a helpful reminder for us all as markets continue to exhibit high levels of volatility and economic uncertainty.
The dramatic events in Eastern Europe which are occurring against the backdrop of high oil prices, Covid-19 mandates, and a US Federal Reserve interest rate hiking cycle has added to the negative sentiment across the board. However, as Seeking Alpha reminds us, “J.P. Morgan research shows that by selling when times get rough and missing out on the market’s best days, investor returns can suffer mightily. Just look at this data from their Guide to Retirement report a couple years back. It compares scenarios where $10,000 was invested into the S&P 500 and was left untouched for 20 years (January 2000 to December 2019) with scenarios where the investor ‘missed’ the market’s best days over that same time frame.”
“The data is shockingly clear that swinging and missing while trying to time the market can lead to major setbacks…”
With that said, we have dialed risk back in portfolios over the past couple of months and believe a below target equity exposure is prudent until things begin to stabilize. Managing investment risk like most other types of risk we encounter is not an all-or-none endeavor, but one of magnitude.
Jason Zweig writes the Intelligent Investor column for The Wall Street Journal. In a recent piece, “How to Invest Calmly in a Chaotic World,” he reminds us that reacting to either short term market developments or forecasts are often emotional, hasty, and wrong.
How to Invest Calmly in a Chaotic World
You don’t have to act on your own forecasts about global events. You don’t even have to make any.
By Jason Zweig
The Wall Street Journal
February 25, 2022
When the world turns upside down, starkly simple views are reassuring. Yet it’s at those very moments that investors need to be even more skeptical about takes that smack of certainty.
As Russia launched its blitzkrieg against Ukraine, my inbox brimmed with reports from investment firms on what you should do next—buy consumer-staple stocks, sell European and Taiwanese shares, buy oil tankers or palladium, sell bitcoin, buy gold, sell bonds.
Remember, though: Just weeks earlier, plenty of politicians, particularly in Europe, thought invasion fears were overblown. In markets, too, many professionals thought the outlook was clear, convinced that the Federal Reserve would act to temper inflation by raising interest rates 0.5 percentage points in March.
Russia’s aggression has crushed such certainty; in a world disrupted by war, the U.S. economy may be too frail to withstand a big increase in rates.
Now that the conflict has sent oil prices near $100 a barrel, investors are suddenly sure the Fed won’t be able to act decisively against inflation. They might be right, at least for now. But what the Fed does is seldom a foregone conclusion, no matter how strong a consensus forms in the market.
That’s because no one can account for geopolitical bolts from the blue.
At its meeting in August 2001, the Federal Open Market Committee, the Fed’s rate-setting panel, indicated it would likely begin raising rates “relatively soon.” Then came the terrorist attacks of Sept. 11, and the Fed slashed rates by 1.5 percentage points in less than two months.
As I warned in January: “Investors who overhaul their portfolios based on what the Fed seems likely to do could get stranded if it does something else entirely.”
Many professional investors reshuffled their holdings in recent months to cash in on what they regarded as inevitable imminent rate changes by the Fed. I expect that, when this year is over, some bond funds that made such aggressive bets will end up reporting poor results.
That points to one of the critical advantages that individual investors have over Wall Street, although you have to be careful not to fritter it away. Unlike professionals, individual investors don’t have to act on their own forecasts. They don’t even have to have any. That might feel like a weakness, when in fact it’s a strength.
Now that Russia has attacked Ukraine and emotions are running high, it might be tempting to get out of the market to keep your money safe, if you’re feeling afraid—or to bet on what sounds like a sure thing, if you’re feeling aggressive. But hasty decisions are often wrong, and big hasty decisions almost always are.
You could try restructuring your portfolio to profit from a scenario that might unfold in the wake of Russia’s invasion, like a boom in U.S. exports of natural gas, or rising inflation and higher military spending.
The risk, though, is that scenarios that seem likely often don’t materialize—and, even if they do, they can become too popular, eliminating the bargain prices that produce superior returns over time.
A couple of things are pretty close to certain.
One is that it’s a bad idea to overhaul your portfolio when you’re afraid. The time to become more conservative is when things are going well, not when the world seems to be coming apart.
Another is to consider embracing surprise instead of fleeing from it.
Would it surprise you to hear that, even after yesterday’s 4% dive, European shares have fallen less this year than U.S. stocks? It surprises me.
The iShares Core MSCI Europe exchange-traded fund, which holds stocks across more than a dozen countries there and has more than an eighth of its total assets in Germany, is down 11.2% so far in 2022. That’s less than the 12.3% fall of the S&P 500.
In periods of geopolitical turmoil over the past half-century, global stock markets have tended to move in sync, says Elroy Dimson, a finance professor at Cambridge University’s Judge Business School. To put it bluntly, when things go bad, just about every market turns red at once, as they did for much of this week. That can make global diversification seem ineffectual in turbulent times.
But stocks around the world don’t fluctuate in lockstep for long, going their own ways again in calmer periods, he says. That can reduce risk and makes global diversification worthwhile.
With U.S. stocks nowhere near cheap by historical standards, this might turn out to be an opportune time to increase your exposure to overseas markets.
On financial markets we remain cautious. The surprise to me is that long-term bond yields have moved up higher than anticipated in the face of a declining equity market. Let’s get through the upcoming FOMC meeting on March 16th and see if correlations begin to shift. My guess is they will.
Justin Kobe, CFA
Founder, Portfolio Manager & Adviser
Pacificus Capital Management
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Advisory services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Cambridge and Pacificus Capital Management are not affiliated. Material discussed is meant for general illustration and/or informational purposes only, and it is not to be construed as investment, tax, or legal advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice. These are the opinions of Justin Kobe and not necessarily those of Cambridge Investment Research, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Investing in the bond market is subject to risks, including market, interest rate, issuer credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counter-party capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Diversification and asset allocation strategies do not assure profit or protect against loss.