Staying the course is not staying still
By Kyle Tetting
It’s been a challenging start to the year. Broad measures of U.S. stocks such as the S&P 500 nearly reached correction territory in the span of the first month of the year. Growth-focused measures like the Russell 1000 Growth index surrendered more than 15%. While bonds fared better, interest rates pushed higher, resulting in modest declines in most bond portfolios. In combination, a balanced portfolio of bonds and stocks finished the first month of 2022 in decline.
While such periods of decline are common, the recent experience for investors has been one of significantly less volatility. Since the pandemic lows in March of 2020, down days have been rare and persistent declines even rarer. As a result, many investors are left wondering how to respond to a return to market volatility.
First and foremost, it’s important to understand that short-term market movements aren’t a rational response to the underlying fundamentals.
Stock prices move quickly, but fundamentals change slowly. These day-to-day price movements are largely a popularity contest while long-term market direction is a math lesson. Expectations for continued strong earnings growth point to meaningful opportunities for stocks ahead as stock prices tend to mirror that longer-term earnings growth.
Patience remains the challenge, counting on appropriate balance to ride out the current storm. But patience, “staying the course” we often say, isn’t about inaction. It’s about small but necessary course corrections to ensure we remain true to the plan.
Notably, this includes a conversation in the good times about slowing down just a bit. There’s a tendency to become overly aggressive as stock prices rise and stock exposure creeps higher than intended. We spent the better part of late 2020 and 2021 trimming risk, planning ahead by setting aside some of the bounty for the leaner times that inevitably come. The best way we deal with market volatility is to plan for it.
Even as we prepared for volatility to arrive, there’s plenty to be done now that it’s here. The uncertainty that drives market corrections often results in shifting leadership. This time around, with the expectation for interest rate increases driving high growth stocks lower, investors seem increasingly concerned about the quality of the businesses they are buying and the price they are willing to pay.
Within fixed income, the potential for higher interest rates down the road offers an immediate challenge to bond investors. Higher interest rates on newly issued bonds make existing bonds with lower yields less attractive. However, as those existing bonds mature, investors will find higher interest rates. A small amount of pain today leads to better opportunities in bonds down the road.
For investors in actively managed funds, opportune shifts take place within their portfolios every day. Over time, bond managers reinvest the proceeds of maturing bonds, and bond and stock managers both make decisions about what to buy and sell to position for new opportunities and risks. It’s frequently unnoticed, but these small changes often add up to the kinds of significant shifts that make a long-term difference.
Beyond the changes within funds, we can also make changes among them. However, rather than make large shifts, market volatility should serve as a gut check on risk tolerance and a reminder of the long-term plan. Small changes within the plan help us stay focused; a desire to make larger changes may speak to a level of discomfort with the current approach.
It seems unlikely the recent volatility will disappear overnight. For investors, next steps must include confirmation of the plan for the road ahead and necessary adjustments to ensure the portfolio remains on target. Rather than disrupt an appropriate balance, we should be looking to lean into opportunity and away from risk. “Staying the course” includes occasional small tweaks to ensure we remain pointed in the right direction.
The case for active funds amid volatility, a Money Talk Video with Kyle Tetting
Staying active as conditions change, edited by Joel Dresang
When Should I …consider actively managed funds?
When Should I …consider passive index funds?
“Active vs. Passive” in Mutual funds, from the Financial Industry Regulatory Authority
(initially posted February 4, 2022)
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