(Morningstar Managed Portfolios) At a glance, recent headlines might alarm the uninitiated. A novice dipping a toe into the current market commentary could easily decide that today’s investors face a particularly fraught environment.
"Markets Are Climbing a Wall of Worry From Evergrande to Delta and Inflation”
— CNN
“China’s Regulatory Storm Risks Triggering Wider Economic Damage”
— The Wall Street Journal
“Stock Market Risks Pile Up After Record-Setting Earnings Season”
— Bloomberg
With so many terrifying headlines, can the markets really continue to climb higher? And should those headlines prompt responsible investors to alter their strategies to ensure they can safely meet their financial goals—or, at least, protect the gains already achieved?
With the economy facing an imposing variety of challenges, it pays to distinguish between the short term and the long, between fear and concern. Fear is an emotion. It all too often springs from the irrational. Concern, on the other hand, responds to a reasoned approach. A long-term outlook favors the reasonable, providing a steady hand and solid guidance informed by careful consideration of what truly matters to markets.
In the short term—over the next few days, weeks, or months—a negative surprise, or even the threat of one, can lead to a sudden downturn in investor sentiment, triggering market losses. Nasty shocks come in all shapes and sizes: earnings disappointments, inflation anxiety, an abrupt shift in regulatory tone, or worries about geopolitical dynamics.
The key is to remember that short-term negative surprises and their accompanying pain don’t necessarily translate to lasting damage to portfolios. Permanent losses are a much less common but more significant concern for investors intent on using their portfolios for objectives that are further over the horizon, such as funding college or augmenting retirement spending.
What causes permanent capital losses and threatens those long-term goals? Broadly speaking, the reasons are three-fold: valuation risk (think the tech bubble of the late 1990s), earnings erosion due to fundamental risks such as secular shifts or technological obsolescence (Blackberry and Kodak are prime examples), and long-lasting inflation, such as what the US endured during the 1970s.
All of that is why Morningstar’s investment management capability adopts a dual approach: we focus on mitigating long-term risk while seeking out opportunities to take advantage of short-term sentiment changes. That’s a key responsibility for us as stewards of capital, working on behalf of investors.
What does that mean for those investors who are spooked by sky-is-falling headlines? An effective way to control fear is to remember that dire news reports and the risks they trumpet are always going to be with us. But few of those headlines will stand in the way of investors with prudently crafted financial plans and investment portfolios that support them.
So where does that leave us with today’s headlines? At Morningstar Investment Management, we’re cognizant of risks of capital impairment (long lasting portfolio damage), particularly from high equity valuations. The challenge there is that bond valuations are terrible, and cash yields a negative return on a real basis. The end result? Stocks may still be the best choice for long-term investors. However, we’re not willing to be overweight, as we prefer to keep some dry powder when stocks aren’t trading near record highs.
We’re also keeping an eye on inflation, though we agree there’s a strong rationale that the rise in prices we’ve seen in recent months won’t be long lasting. However, as investors and not economists, our concern is ensuring the portfolios we manage can withstand a variety of market environments. To that end, our analysis suggests that limited exposure to interest rates from fixed income and an overweight to energy should offer a measure of protection in the event inflation lasts longer than many predict.
In terms of the other terrifying headlines—namely China’s recent developments and the spread of COVID-19—we’re not convinced they will result in long-lasting damage and are thus more inclined to modestly increase exposure to impacted markets when they suffer severe selloffs.
We don’t pretend to have a crystal ball, and there are plenty of potential outcomes that we could very well not foresee—even those related to headlines that strike us as overwrought. That said, experience suggests to us that a steady hand tends to stay on course. As always, we appreciate your business and keep you front of mind as we navigate market environments.
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