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Wealth Insights | Economy | Asset Allocation

Weekly Market Analysis: Why Not Just Sit This One Out?

 

3 Things to Know         

The cost of being very defensive

Historically, there are many reasons why “going to cash” is a costly decision over the long run. The first of these is the loss of value creation on the market’s best days. Great “up days” can happen at any time, of course, but often occur around market turning points.

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Living through macro policy madness

Week after week, month after month, CIO has assessed the macro policy moves of central bankers globally, watching them address a global pandemic, a major European war, and a Chinese real estate meltdown using tools that are never “fit for purpose.” Tighter or looser monetary policies are blunt instruments when applied to specific, exogeneous economic circumstances.

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Developing perspective

The boom and bust of markets of 2021-2022 need to be understood with perspective. Both the rise and fall in markets are just “moments” in the life of one’s portfolio. Investors who won’t recognize the value of equities in long-term portfolios will suffer if they fail to stay allocated or fail to reallocate to equities as their value builds.

 

Summary

At this moment, it would be easy for investors to throw up their hands in resignation and simply refrain from investing altogether. Markets have dealt investors a rough hand so far in 2022. A continuous patter of market-churning news paints a picture of stubbornly high inflation, tightening monetary conditions, a slowing economy and disrupted global energy supplies. Citi Global Wealth Investments raised the chance of recession in 2023 to 70%. Why not just sit this one out?

In this Bulletin, CIO looks backwards to look forward. What happened to investors who stayed invested through the dot-com bubble and the Great Financial Crisis versus someone who did not? And what are the real drivers of wealth creation that we may be less aware of?

Portfolio performance of two hypothetical investors:

Jack and Jill

Source: Haver and Bloomberg as of September 29, 2022. The illustrative example of Jack and Jill do not reflect the actual investments  of any portfolio and are shown purely as examples. Past performance is no guarantee of future results.

Portfolio considerations

Dividend reinvestment is more than a powerful contributor to total equity returns. More than 2% per annum may be earned just by “checking the box” and reinvesting your dividends.

 

The cost of being very defensive

To illustrate the ill effects of market timing, we compare two hypothetical investors: Jack liquidated his portfolio with perfect timing, just before the tech bubble burst at the end of February 2000. He missed the 49% drop in the S&P 500 and invested the profits he made in the previous 5 years in US Treasury bills. The other, Jill, stayed invested through that downturn as well as the Global Financial Crisis. She saw her portfolio drop 49% from 2000-2002, and 51% in 2008-09, and another 20% in 2022. Whose portfolio performed better overall? As of Sept. 30, 2022, Jill’s portfolio wealth, measured in real terms, would be about 3 times the level of Jack’s. Big up days can happen at any time, of course, but often occur around market turning points. Looking back to January of 1990, a period of 11,961 calendar days encompassing approximately 8,258 trading days, and one misses just the top 10 trading days for the S&P during that period, the loss of potential value would have been more than 50% of the total return for the entire period.

Living through macro policy madness

The world economy is poised to suffer a hangover in the year to come. In response, markets are showing increased signs of stress and even disfunction: (1) The price of food has skyrocketed on global supply issues. As a policy answer, the Fed is using the blunt force of US monetary policy to send the housing market into a tailspin. While rent measures in the CPI will continue to climb, August saw the first decline in national home prices since 2011; (2) The Bank of England is again intervening in its bond market with “unlimited long-term bond purchases” to control interest rates following a record yield spike and currency plunge. This is after the BoE raised base lending rates 7 times in accelerated fashion during the past two months.

Developing perspective

The boom and bust of markets of 2021-2022 need to be understood with perspective. Both the rise and fall in markets are just “moments” in the life of one’s portfolio. In recent years, CIO lamented the sharp decline in bond yields to levels CIO believed would harm asset allocation portfolios. The Global Investment Committee’s underweight in global bonds was as much as - 12% last year. CIO feared that quality fixed income securities were so richly priced that they would not be able to rally when equities fell. This calculus has now changed as yields have surged. While dropping sharply in value this year, the rise in bond yields in 2022-to-date has raised the prospective nominal 10-year return of the US bond market by about 2.5 percentage points per annum.

Portfolio considerations

Dividend reinvestment is more than a powerful contributor to total equity returns -- more than 2% per annum may be earned just by “checking the box” and reinvesting your dividends. But that’s not all. From 1990 to now, the average inflation rate has been 2.74% per annum. The gain from reinvesting dividends has been 2.19% a year. Simply put, earning and reinvesting dividends have been one way of alleviating the detrimental effects of inflation. Corporate earnings, dividends and stock prices are inflation hedges, meaning they include price adjustments due to inflation. When you buy a bond, in contrast, the return of principal isn’t adjusted for inflation. Therefore, when we’re out of the market we lose the ability to have equities maintain (and possibly enhance) the value of our portfolios, net of inflation.

Note: Past performance is no guarantee of future results. Real results may vary.