The gains across global equity markets over the past six months have both surprised and frightened investors. Although it is always welcoming to see portfolios increase in value, the idea that the increase may be fueled by a complete lack of fundamental factors has caused tremendous angst on the possibility for near-term volatility. The wounds of the March 2020 COVID bear market are still fresh, and many investors remain fearful that a market correction of similar magnitude is imminent. The fear of missing the upside, however, is still highly relevant when considering the tremendous gains of last year, which puts many investors in a fearful limbo stage. I want to address concerns this week on why the downside fear factor remains irrelevant over the long-term and I want to focus on four objective things to keep in mind as we all continue to grapple with this environment.
For starters, it is important to note that the current environment remains both misunderstood and highly opportunistic. It is misunderstood in the sense that investors view market indices as a true depiction of the underlying health of the stock market. That is simply not true, at least not in today’s environment. The performance and risk profile of the S&P 500, for example, tells us very little about the average health of any one of those 500 companies, nor does it correctly express the opportunities within the index that embody valuation metrics that remain highly favorable. The attribution of mega technology stocks to the risk and return profile of the index has generated a deep dislocation that masks underlying opportunities. Secondly, our approach to global asset allocation, alongside active multi-strategy generation within each asset class, remains highly sensitive to valuation risk and attempts to pinpoint short-term opportunities. This is important as it relates to the market’s growth concentration, a segment driven by excessive valuations and exuberant sentiment. It is no secret that such characteristics have historically fueled bubbles, the likes of which never end well. Investors who have only marginally participated across such exposure, however, have often benefited to the downside (on a relative basis), as was the case with foregoing technology exposure in the depths of the dot-com bubble in the early 2000s. Be that as it may, the third main component to keep in mind is that excessive valuations on a standalone basis are never a solid market timing tool. The famous economist John Maynard Keynes once said, “markets can remain irrational longer than you can remain solvent”, which references the notion that exuberant behavior can define markets in a more dominant way than any rational investment approach can (at least in the short-term). It also focuses on the notion that market timing does not work. Simple as that. Rather, a focus on risk management remains paramount, which is why our platform continues to actively participate in the growth segment of the global equity market in a way that avoids concentrations that may negatively impact returns amidst volatility. The decision to forego such exposure would not be entirely appropriate, despite excessive valuations, because we would be indirectly timing market activity, a concept that we never subscribe to. This speaks to the notion that being fearful of strong and persistent gains is never a good enough reason to exit equity market participation. One must simply manage risk around it.
The fourth and last point that remains highly relevant in today’s markets is the idea that investors cannot appropriately decipher event-driven economic and political actions. It is by far the hardest component to quantify, which makes it extremely fragile to attempt and apply to market fundamentals. We covered this extensively in our coverage of the COVID bear market last year within our video series. Event-driven cycles, such as the current COVID cycle, are entirely emotional in nature rather than fundamental. Unlike the global financial crisis, which was caused by a true fundamental issue in the banking system, the current cycle is notably less tangible and more difficult to understand. As a result, political and economic data points provide a different path to a recovery, which is one that looks unlike anything in the past. Not only are consumers able to appropriately justify demand this time around, but opportunities remain abundant for investors (especially on the international front).
We have already shifted course in capturing opportunities and stand ready to further engage across global markets.
Edison Byzyka, CFA – Chief Investment Officer – Credent Wealth Management
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg.
All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations.
Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan.
Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.
Manufacturing data – Markit PMI – Bloomberg
Economic Policy Uncertainty data sourced from Bloomberg via The Baker, Bloom, and Davis Index.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changed in the aggregate market value of 500 stocks representing all major industries.
International markets are represented by the MSCI EAFE.