Often people come to me and ask for my investment strategies for the market. While I do not have a crystal ball, I certainly have an opinion.
Depending on the person, there may be multiple investment strategies to manage risk while extracting an investment return. In formulating an investment strategy, an investor should consider many factors, including investment timeline, risk profile and financial sophistication. Also, recognize that an investment strategy for one individual may be inappropriate for another. With that being said, I believe staying informed on current events helps all investors feel like they can weather the ups and downs in the capital markets a little more easily.
2019 Capital Market Drivers: Trade War Concerns & US Federal Reserve
In my opinion, the two largest near-term drivers to the capital markets are the trade war concerns and the Federal Reserve. Currently, there are signs of the global world economy slowing down, particularly in the manufacturing sector. I believe that the manufacturing sector weakness is significantly affected by international (tariff) free trade policies, which deteriorated significantly this year.
In response to the slowing global economy and perceived risks, approximately $17 trillion in debt is now trading at negative interest rates. That is, bond investors are guaranteed to get back less on their investment than their original purchase price – an unusually unattractive scenario for bond investors. The Federal Reserve made a “mid-cycle” adjustment and is now on a trajectory of lowering (instead of raising) interest rates, in part due to these issues.
These market drivers could be interpreted with optimism or pessimism. Let’s walk through the narratives.
Investment Strategies from an Optimist Perspective
A positive near-term narrative for stocks goes something like this:
- President Trump’s reaction to the US trade policies has largely created the current friction on trade, and therefore, he controls the levels to make this problem go away.
- Both sides (the US & its trading partners) have a significant economic incentive to resolve this dispute.
- President Trump would benefit from a strong economy during 2020, a general election year.
- Impeachment proceedings will put pressure on President Trump to deliver good news on the economic front, a major component of his re-election campaign strategy.
- Trade resolution would remove uncertainty from the marketplace, causing both businesses and investors to become less risk averse.
- Substantive trade & tariff relief would remove an anticipated drag on projected 2020 growth.
- An additional boost to 2020 growth could occur, as growth from 2019 is effectively “pushed” into 2020.
- Any trade deal (substantive or not) would likely remove perception of economic risk, especially in international and emerging markets.
- The Federal Reserve policy should remain accommodative until tangible signs of growth or inflation are well established.
- Bonds, the traditional alternative asset choice to stocks, represent an unusually unattractive investment returns, except in a dire economic scenario.
Potential Capital Market Reaction: If this scenario played out, it would likely be positive for stocks and high yield bonds. Stocks that may disproportionately benefit in this scenario would be value stocks, stocks with overseas sales and supply chains, and certain industry sectors (economically cyclical, industrials, financial). Demand for high quality bonds (a recession hedge) may decline, resulting in lower prices and higher yields in this asset class.
Investment Strategies from a Pessimist Perspective
The pessimist narrative on stocks is as follows:
- While President Trump may have been the catalyst for the trade war, he is now not fully in control of getting a resolution. Other trading partners, primarily China, need to go along with a “deal”.
- China, which has a greater political tolerance to play a long game, may not want to make a deal on substantive trade issues, and may choose to wait to see if there is a new administration with different priorities.
- Impeachment proceedings may overshadow any progress on trade war issues.
- There isn’t great pressure on President Trump to get the trade deal resolved. In a “no deal” scenario, he can bolster his reputation as being tough negotiator, which will help him with certain political groups for re-election.
- Even if there is a substantive deal, it wouldn’t impact real growth in the economy, which is running at full capacity, as indicated by historically low unemployment rates.
- Continued uncertainties about the economy and potential escalation of trade conflicts will keep world economic growth muted and fears of recession high.
- High quality bonds, the traditional alternative asset choice to stocks, offer a measure of safety in an environment where stocks could lose value.
Potential Capital Market Reaction: In this scenario, investors would be drawn to financial assets with less risk, such as high-quality bonds. Interest rates would likely remain historically low, which could make quality growth stocks appear relatively more attractive. Riskier assets, economically sensitive stocks, and credit sensitive bonds would have a higher likelihood of relative underperformance. If the economy were to deteriorate into a recession, most stocks and high yield bonds would fare poorly.
What Is a Proactive Investor to Do?
While I believe in a long-term investment strategies, this does not mean sticking your head in the sand when external facts change. I always recommend staying diversified, as the unexpected often happens, particularly in “late cycle” economic expansions. However, there are several things proactive investors can do to improve their situation:
- Ponder Your Investment Strategy Before Portfolio Shifts: Before you do anything with your portfolio, think about if making any changes to your portfolio is consistent with your long-term strategy. For instance, if you are a long-term investor (10+ year time horizon), then current events may not affect your portfolio strategy. If you do not have a long-term strategy, then this should be your priority, rather than making changes in your portfolio.
- For Portfolio Shifts, Understand Your Investment Themes Before Selecting Your Investment: There are plenty of ways to manage risks with investment selection. For stocks, there are growth and value stocks, large-mid-small capitalization, and industries choices that may all materially affect the overall performance of your portfolio. For instance, in the last few years a low interest rate, low GDP growth environment has pushed up the valuations of high-quality growth stocks. However, market leadership can change quickly, and other types of stocks may begin to outperform. Therefore, know where you want additional exposure, then choose the right investment vehicle. If you are a participant in a 401(k) plan, you should have educational support to help you navigate your line-up.
- Implement & Monitor Your Strategy: When you are ready to make a change, write down your thought process and then adjust your portfolio. If you are uncertain about this step and you are looking for a thoughtful way to “tilt” your portfolio towards one of these (or another) scenario, you should consider consulting with a personal investment adviser. They will likely have ideas that may have a favorable risk/reward profile that you may not even know exist. In addition, investment advisers can offer an opinion if your current investment portfolio matches up well with your long-term strategy.
If you would like expert advice on making investment strategies that match your unique goals, please call me, and let’s set up a time to talk through your options.