As recent events have demonstrated, markets can be highly-unpredictable. Asset prices continue another month of decline as rising interest rates provoke recession fears. We remind clients that the market is forward-looking and will anticipate the end of inflation and interest rate hikes before they happen. But the market can’t predict the psychology of infectious selling.
As long-term investors, we need to remain humble and not overestimate our ability to predict the outcome of market events. What we can do, however, is thoroughly assess the investment landscape. As patient long-term investors operating in a market influenced by fear and greed, we understand that excess returns could become available when an asset’s price diverges significantly from its fair value. The caveat is that, given the level of uncertainty, we would like to see a wide gap between current prices and fair values when we make an investment decision. So far this year, we have been able to add great companies to the portfolios due to wide price swings that don’t reflect the underlying value of the businesses.
For many investors, it can be tempting to predict where the economy or market is heading. The challenge, of course, is that this is notoriously difficult to do because you need to predict the future twice: once to get out of risky assets at the right time and again to reenter them at the bottom. Adding to the complexity, consider that since 1928 the S&P 500 has had one bear market every four years on average. With the S&P 500 now down 20% from its peak in January, this is now the 3rd bear market we’ve experienced in less than four years. Proving yet again that timing markets is impossible.
So, what to do in this environment? We encourage investors to hold assets that may protect against a spike in inflation. We believe that investors can benefit from buying into negative sentiment, especially when they are willing to take a long-term view. We remind clients that most economic recessions prove temporary. Nothing lasts forever, and this downturn will eventually end. If history has taught us anything, markets will eventually correct and go higher. Warren Buffett’s Berkshire Hathaway has used the slump as an opportunity to increase spending on stocks, deploying billions of dollars over the past couple of months. But, as a recent article put it, “with tightening monetary policy, slowing economic growth and sustained supply-chain disruptions putting markets on edge, Mr. Buffett is in his element.”
Diversification is an essential tool for managing uncertainty. Corporate bonds and equity markets can behave very differently, yet both are susceptible to economic shocks as we’ve seen this year. The important part is to diversify against fundamental risks. We want to be diversified to reduce the impact of any downturn, but taking a long-term view, we focus on the price paid for those assets. We also want to avoid interest rate risks in our bond portfolios by keeping maturities short so we can reinvest proceeds at higher rates.
In equities, there have been clear winners and losers, with energy companies rallying more than 30% year-to-date. Many high-quality companies are represented in your portfolios. Dividend-paying stocks have outperformed the S&P 500 this year, partly because investors whipsawed by market volatility have sought out stocks that can offer steady cash returns. We have taken advantage of the chaos to add solid names trading at favorable prices. This is one of the many areas we can add value by maintaining a long-term view when others don’t.
Many thanks for your business, friendship and support. Please let us know if you have any questions or would like to get together to discuss your portfolios.