It’s been a difficult year in the markets so far, and the volatility is occurring on many fronts at the same time. A robust risk management framework that considers all types of risk, both long and short term, is essential to navigating the uncertainty.
On the geopolitical level, the war in Ukraine has injected uncertainty into global energy and food markets. On the economic front, central banks are increasing interest rates to counteract inflation.
Rising interest rates, in turn, have led to a drop in bond prices not seen since the early 1980s. As discussed in our first-quarter update, we’ve buffered client portfolios from rising rates by shortening bond maturities.
At the same time, there’s been a pullback in stocks with the U.S. market down more than 10%, which is commonly referred to as a correction. (The Canadian market has held up better thanks to the strong performance of energy, mining, and agriculture-related stocks.)
Against this backdrop, one might have assumed that Wednesday’s announcement by the Federal Reserve, a widely expected increase of 0.50% in the fed funds rate, would create more doom and gloom. On the contrary, markets cheered the fact that Jerome Powell downplayed the likelihood of larger increases in the future. The S&P500 ended the day 3% higher. Unfortunately, while I write this, it seems those gains will be erased.
However, this is a fitting reminder of why we don’t try to time the market. It is impossible to know in advance how new information will change investor expectations. It also reminds us that problems don’t necessarily need to be ‘solved’ for the markets to go up. They just need to get slightly less bad.
This was exactly what happened in the depths of the pandemic induced crash of March 2020. In hindsight, the stock market bottomed out long before vaccines were developed, before the economy had recovered, and before the virus had run its course (aren’t we all hoping that it finally has?!?)
I obviously don’t know if stock markets have bottomed, or if there’s more downside to come. What I do know is that if we focus on managing risk in relation to each client’s needs, we’ll create the best odds of a successful investment experience over the long run.
Given the current environment, the conversation I’m having most often with clients is about the balance of interest rate risk versus stock market risk. As previously mentioned, we’ve taken steps to reduce interest rate risk by shortening the overall maturity of the bonds we hold in client portfolios. The question becomes whether it is appropriate to take on a little more stock market risk, to make the portfolio more resilient to inflation over the long term.
This is a conversation that is specific to each client’s circumstances and goals, so if it is on your mind and we have not yet spoken about it, don’t hesitate to reach out.
Downturns are never pleasant, and they feel different every time. If it were any other way, markets wouldn’t be as rewarding in the long run. To successfully build wealth, we must have the humility to admit we don’t know what the future holds, and the patience to reap the gains the markets offer over the long-term. At the risk of being trite, Voltaire’s words remain relevant: “Doubt is an uncomfortable condition. But certainty is an absurd one.”
Source: Yahoo Finance