Investment Comment
6th January 2023
Give the sales a pass?
Back in the day, eager shoppers looking for a bargain would queue outside shops, overnight and even longer, to snaffle up bargains as the doors opened. Nowadays, it’s deal-hunting season on the internet and in markets, or so our psychological selves tell us. A guilty pleasure for some this time of year is to scan websites for good deals, sorting by the biggest percentage discounts. Anybody who has gone down this dark path already knows that this is a fruitless exercise. All it leads to is hundreds of listings of absolute garbage. Investors often make the same mistake during bear markets.
Do not equate big price declines to value. Nearly one year into this bear market, some have begun to scour the lists of the largest decliners for big discounts, failing to realise that those lists are dominated by prior market leaders for which the risk of failure was drastically under-priced. Large historical price falls do not necessarily result in future gains. As the table below clearly demonstrates, the biggest decliners in the first year of the US bear market in 2000 were dominated by underperformers and failures. A similar table can be shown for the 2007 bear market. In each cycle, eight out of ten of those biggest initial decliners — not including the decliners that didn’t last a year from the peak (e.g. Lehman Brothers) — underperformed the market significantly in the subsequent decade (or however long they continued to trade).
Source: Richard Bernstein Advisers, Artorius
Investment advice for the ages: how to invest in recessions
2022 was difficult and emotional discipline continued to be a key strategy to handle the volatility. In the short-term, until the economic policy environment improves, volatility is likely to remain a constant. It may be worth reiterating some hard-won lessons of previous bear markets to ensure navigation of the current recession.
Recessions cut deep across stock market history. The recession and financial crisis of 2008–09 remains a fresh memory for many investors, the Technology Bubble, and burst, lingers in the recesses of older minds, whilst the near antiquities may remember the events of Black Monday in 1987. For those old enough to remember labour disputes and energy shocks of the 1970s, congratulations for reaching old age, and apologies for the repeat showing.
Recessions happen for different reasons and often coincide with or accompany bear markets in stocks, but many fundamental principles of investing and portfolio strategy remain constant. Examining how stocks have responded in previous recessions, as well as common mistakes investors make, can help inform and enlighten your portfolio strategy. Here are a few basics on recessions and markets, plus mistakes to avoid during a pullback.
What causes recessions?
Historically, recessions have been triggered by a few factors, including a supply or demand shock in a global commodity like oil. Recently, for instance, the COVID-19 pandemic exposed instability in the complex global supply chain that created a wave of supply shocks rather than the more commonplace demand shocks that are more usual in expansions.
Another form of recession could be driven by the Federal Reserve. For example, in the early 1980s, the Fed sharply hiked benchmark interest rates in an effort to damp down soaring inflation. If the central bank is too hawkish in its monetary policy, or not accommodative enough, economic growth can suffer, which is likely to be the cause of the recession or sluggish economic growth in the US in 2023.
Another form of recession is sort of a credit "reset”, a period of rapid deleveraging in the wake of an asset bubble bursting, such as what happened in housing (2008 financial crisis) and technology stocks (1999–2000). Depending on the cause and nature of the recession, markets may react differently, as will policy makers.
Investor mistakes during recessions and bear markets
Though volatility and price swings lead to lots of market drama, at the end of the day, most market analysts believe the fundamentals of stock investing remain firmly in place. That makes it particularly important to try to keep emotions in check, maintain a disciplined investing strategy, and avoid these three common investor mistakes during market downturns.
- Selling at the bottom of a market
Nose-diving markets are often fuelled by panic selling, which any investor with a long-term plan should avoid getting sucked into. Unload stocks during a slump, and you may just be locking in losses and eliminating any prospect of gains if prices recover. Most market specialists agree the more prudent approach is to ride out the volatility and wait for the recovery. History shows the best opportunities to accumulate assets often come after the worst period for markets.
But again, past performance does not guarantee future returns.
- Trying to time the market using economic data
Many economic readings are lagging indicators—snapshots of a previous month or quarter. Investors must consider macroeconomic data in the context of company or industry fundamentals. Looking at macro data by itself can potentially cause you to be late to react to what the market is doing. A better path might be to focus on valuations and the prevailing market sentiment of asset classes as well.
- Being too concentrated in certain assets and not diversifying
Too many eggs in one market sector basket can be a recipe for trouble, and bear markets can change the way some companies are valued. For example, before the 2008–09 financial crisis, many financial companies were considered blue-chip, high dividend-paying stocks. But as some of those companies collapsed, their market value largely disappeared. Lacking diversity can leave some investors with stocks that have been repriced permanently.
Outlook
With a longer Investment Outlook scheduled I surmise our view for 2023. While the prospect of easing interest rate pressures should be a constructive theme for markets in the first half of 2023, the associated weakening of growth remains a challenge.
A reasonable central scenario is one in which investors can expect to achieve solid returns from high quality assets, albeit probably having to ride out plenty of turbulence along the way.
With most of the rate hiking cycle now behind us and with asset valuations notably more attractive than they were at the end of 2021, 2023 should be a better year for investment returns than 2022.
A key question for investors is the fate of wage inflation. If wage inflation quickens then this may have two detrimental effects. One would be to keep the Central Banks on the watch for further inflation and so less likely to cut rates in 2023, and the other would be to eat away at corporate profit margins.
Gerard Lane Chief Investment Officer
Artorius provides this commentary in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 6th January 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
The value of investments and the income from them could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance of an investment or asset class is not a reliable indicator of future results. Nothing in this document is intended to be, or should be construed as, regulated advice.
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FP20230106001 EXP 03/02/2023