In a Bear Market:
- Defense matters – We have lowered stock weightings.
- Position sizing matters – Due to the greater volatility.
- Yield matters – Hence our preference for ‘PATTY’ themes.
Here's how this Reality has Played out in our Balanced Portfolios
The Major League Baseball (MLB) conference championships have begun with the winners going to the World Series and the losers going home. Games with high ‘stakes’ demand strategies that differ from those used throughout the 162-game regular season. Investment strategies should also adapt to the size of the stakes, in our opinion. Studies show that investors feel losses twice as acutely as gains, bear markets carry higher stakes than bull markets. We believe this can lead to loss aversion behavior that causes one to abandon an appropriate financial plan at or near market bottoms.
Given that financial markets are officially in ‘bear’ territory, our strategies have adjusted in three ways, which have affected the positioning of RiverFront’s balanced portfolios.
1. Defense matters: The statement that ‘defenses win championships’ is not only true in baseball, but also investing, in our view. The simplest way to be defensive is to allocate fewer dollars to riskier assets, like stocks. Each of RiverFront’s balanced portfolios have reduced their stock allocation throughout the last 12-months and currently carry fewer stocks than they would in a bull market. Our stock reductions have ranged from 6-13% over the last 12-months, with the largest reductions occurring in our shorter horizon, more conservative portfolios (see table below).
2. Get on base: There are times to ‘swing for the fences’ and there are times to target getting on base. We believe the latter is a better strategy in the play-offs and during bear markets. In the play-offs, only the best pitchers pitch and they are often throwing their best stuff. According to a 2018 MLB study, the average play-off fastball in 2017 was a full one mile-per-hour faster than those thrown during the 2017 regular season. Therefore, ‘swinging for the fences’ in the post-season carries a higher risk of striking out.
Shifting to investing, bear markets also present unique and difficult challenges. Stock and bond markets that move in value by multiple percentage points in a day or swing wildly from positive to negative over a short period of time, are great examples of these challenges. In these types of markets, we place particular emphasis on sizing our positions appropriately so that no one position, or trade, has outsized (‘strike-out’) impact on our portfolios. A few areas that we currently like include:
- We like higher yields on bonds: It has been painful for investors this year in fixed income. However, as a result of yields rising, we see opportunities in bonds to benefit from current yield levels – the Bloomberg Aggregate is yielding 5.15% as of October 21, 2022.
- We like US stocks relative to International: The US is still the strongest major economy in the world with less exposure to geopolitical issues in Europe and Asia, in our view. International stocks, while looking more attractive from a valuation perspective, possess structural growth concerns and contagion risks are higher.
- We like the US Dollar: We believe that the US Dollar will continue to appreciate against most foreign currencies, and we are hedging a portion of our non-Dollar exposure in our portfolios.
- We like ‘stock picking’: We continue to favor more granular security selection, favoring investments that we think can benefit or quickly adjust to the new geopolitical reality – a ground war in Europe and a ‘cold war’ in Asia.
3. Favor the players that can deliver: Hall of Famer Reggie Jackson was nicknamed ‘Mr. October’ because he could be relied upon in the post-season. He may not have always played his best in the regular season, but when the stakes went up, he consistently shone. We believe that financial markets have their own version of Reggie Jackson, which we have nicknamed ‘PATTY’. PATTY stands for Pay Attention to The Yield, which is another way to say: favor the investments that are delivering results when it counts. Not every stock or bond fits this classification. A few examples of investments that fall into either category include:
- Favor: Inflation recovery plays: We anticipate that the earnings of companies in the energy and mining industries will be resilient because they typically respond positively to inflation and nominal growth. Additionally, we favor countries and regions like Canada, Australia, Norway, and Latin America that export commodities while avoiding the conflict in the Ukraine and tensions with China.
- Favor: Mega-cap, high cashflow technology: Companies with multiple connections to consumers and businesses can use their dominance and scale to maintain sales and pricing power, in our view.
- Favor: Bonds: With Treasury yields at 4% or better from 3-month bills to 30-year bonds as of Friday, we expect a significant shift from equities to fixed income. For example, retirement plans modeled to payout a 4% distribution, can fully ‘lock-in’ a portion of that future liability by purchasing Treasuries today.
- Favor: Healthcare: We believe healthcare-related investments can continue to deliver revenues, earnings and cashflow since their products and services tend to be non-discretionary and their business models are often protected by regulations.
- Avoid: China: China’s apparent crackdown on capitalism, uncomfortably close relations with Russia and its increasing isolation from the West have soured investors on investing in the region. We believe it will take many years to reverse this psychology and thus do not view China-related investments as fitting the PATTY profile.
- Avoid: Expensive growth stocks: Expensive growth stocks are the poster child for ‘non-PATTY’ investments. While we think there are plenty of great companies with good long-term potential in this category, many are unable to deliver earnings, dividends and/or cashflows today. For this reason, we expect them to attract less attention in bear markets, when investors demand greater certainty and reliability.
- Avoid: Consumer Discretionary: The US consumer is being battered by the high costs of essentials such as rent, food and gasoline. Therefore, the pressure on revenues, earnings and cashflow in the near-term will be significant, in our view.
Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.