BY: LINDA S. PARENTI, CFA - CHIEF INVESTMENT STRATEGIST
These are certainly tough times for both equity and fixed income investors alike. Federal Reserve officials have convinced markets they’re taking an aggressive path of tightening ahead which continues with two more rate hikes of 0.50% each in June and July. As a result, interest rates have risen dramatically causing historically large declines in bond prices, especially in long dated maturities. Stock markets are in or near bear market territory as recession fears rise. And high inflation persists while cash yields remain low, resulting in a loss of purchasing power.
Although a recession ahead is more likely than not given the Federal Reserve’s task to lower inflation, the timing of when one might arrive is up for much debate. In uncertain times when we hear compelling reasons for a recession ahead it may seem logical to reduce one’s equity exposure. Just wait things out and get back in when the forecast is rosier. The problem with that tactic is once the economic outlook is more reassuring, equity prices have typically moved higher already, sometimes significantly. Economic cycle timelines don’t line up perfectly alongside equity market cycles because stocks are priced looking forward.
When a recession is expected ahead, analysts assume corporate profits will be lower in future. All things equal, lower earnings expectations translate back into lower stock prices. However, recessions are followed by recoveries during which corporate profits rise. It’s expectations for higher earnings in future quarters that then boosts equities. For example, our economy completely shut down during 2020, yet the S&P 500 rose 18.4% that year anticipating a strong economic reopening in 2021. For this year, the earnings picture is still predicting growth ahead. Most of the companies that make up the S&P 500 index have reported their first quarter results and on a per share basis, profits have grown 15%. Earnings estimates for future quarters remain positive as well. Currently, higher earnings combined with lower prices are making equity valuations look much more attractive.
Of course, investors know it’s much better to buy low than to sell low. However, that doesn’t make living through such volatile markets any easier. While it may feel like you should take some action, the key to optimizing returns and minimizing losses is taking the appropriate actions at the right time. During positive market periods, it may seem routine or even tedious to regularly rebalance portfolios, trim winners, and replenish fixed income and cash. But that is the important work that is done to prepare portfolios for down periods. During down periods, it is important to maintain and manage holdings within equity allocations. Taking advantage of opportunities to harvest losses and reinvest in names that have more potential. Or to realize gains in attractive holdings and immediately repurchase to raise the cost basis, lowering a future taxable gain burden. Additionally, if you have excess funds not needed for cash flow distributions over the next four to seven years, down periods such as these are an excellent time to add to equity allocations. Selling when prices are high and buying when they are low sounds easy, but in practice it takes discipline and resolve. And sometimes the assistance of a professional advisor to help your portfolio weather the market’s ups and down. Let us help you.
Linda S. Parenti, CFA
Chief Investment Strategist
RISKS AND IMPORTANT CONSIDERATIONS
Views and opinions expressed here are for informational and educational purposes only and may change at any time based on market or other conditions or may not come to pass. This material is not a solicitation to buy or sell securities and should not be considered specific legal, investment, or tax advice. The information provided does not consider the objectives, financial situation, or needs of any specific individual. All investments carry a degree of risk and there is no certainty that an investment will provide positive performance over any stated period. Equity investments are subject to company specific and market risks. Equities may decline in response to adverse company news, industry developments, or economic data. Fixed income securities are subject to market, credit, and interest rate risks. As interest rates rise, bond prices may fall. Past performance is no guarantee of future results.