** Your Capital is at Risk ** This is not investment advice.
Markets have been in correction mode, particularly since the start of April. I wanted to update investors with my thoughts along with any potential action points – together with what I’m personally doing.
What caused the volatility?
With inflation remaining persistent, central banks around the world have remained firm in raising interest rates to demonstrate their resolve to fight inflationary pressures. Bond and stock markets have responded with surprise around the firmness with which central banks (particularly in the US) have remained true to their mission. The level of surprise in bond markets is captured in the chart below – the yield on the US 10-year bond recently broke 3% …
In the Investment Academy classes we often reference the US 10-year yield as something to watch. Bonds dislike rising rates and inflation so a bond sell-off means yields go up. In turn, stocks don’t react well when bond yields rise aggressively – particularly growth stocks like technology. There has also been related concern that central banks could be making a policy mistake by raising rates – particularly if that results in pushing economies into a fresh recession. Combined, this has led to both bond and equity markets selling off.
Year-to-date performance: interestingly, the better performers are the more popular “Core & Satellite” selections taught in the Investment Academy (the middle section in chart below)… Performance data as at the time of writing (9th May)
Will there be further downside?
We know how attractive equities are over longer periods but the short term is always difficult to forecast – i.e. don’t believe anyone who thinks they know. Early this year I felt markets could pause for breath in 2022 but I certainly did not expect a recession.
Currently, the markets are pricing in a possible recession. If one materialises, you should expect further downside. If not, and the central banks prove not to have made a policy mistake, the markets will see a rebound. As things stand, I personally would guess the odds of a “proper” recession being 30-40%. Even if we do see a recession, i wouldn’t expect it to be very deep because balance sheets of households and corporates are in good shape – i.e. debt levels are relatively low. Deep recessions arise when debt levels are unmanageable with consequences like negative equity.
Whatever happens, remember this: historically, recessions have been fantastic opportunities to buy equities on sale.
What to do now?
- If you are at the Accumulation Stage of your investment life (i.e. pre-retirement and continuing to build your asset base): use sell-offs to acquire the market with patient pound-cost-averaging.
- If you are at Drawdown Stage: stay diversified and balanced. Remember, even if you drawing down, it’s likely the majority of your assets will need to remain invested to beat inflation (depends on your time horizon and spending needs – seek regulated advice if unsure).
- Either way, if you are heavy in cash: start thinking about patient Pound-Cost-Averaging and the timing of that first entry point. Read how PCA produces great results, even in a crisis
Defensive Asset Classes
In a world where interest rates are going up, no asset is truly defensive. Normally, cash would be the ultimate defensive asset but double-digit levels of inflation means cash is still the only asset guaranteed to keep eroding in value.
Other ways to invest whilst being mindful of the risks:
– Dividend ETFs and stocks: Stable, low-volatility stocks that continue to pay out dividends regardless of how the markets move
– Min Volatility ETFs – Stable low-volatility companies and stocks that have “lower betas”
– Commodity ETFs: if inflation remains stubbornly high, commodity ETFs may continue to outperform
– Government Bonds: Typically, during recessions, government bonds tend to give good positive returns because they benefit from a flight to safety. Not always – especially if inflation is also accelerating (remember, bonds don’t like inflation). But a deep recession would almost always result in strong returns for government bonds.
Worst-case scenario?
Stagflation. This is when a global recession is accompanied by persistent inflation. The last time this happened was in the 1970s. To an extent, some in the markets are fearing this might happen again with both equities and bonds selling off. If we revisited a proper severe stagflation, no major asset class would be immune. Not equities, bonds, nor property. Gold might hold up perhaps.
What am i doing right now?
I’m a long-term accumulator so my excess cashflows (from rents and other sources) are patiently pound-cost-averaging into globally diversified equity ETFs.
*My objectives, risk profile and time horizon will be different to yours. So please take your own circumstances into account before making investment decisions*
More importantly, what is Warren Buffett doing?
Latest filings revealed he has been buying the dips. Adding to his favourite stocks.
*WB has been wrong before so it’s possible he is wrong to be buying the dip now. Moreover, he has different objectives to the rest of us*
Ways to mitigate downside (if already invested)
If already invested: Minimise your FITs (Fees, inflation, taxes). Or earn additional income to mitigate the temporary capital declines.
Fees: Remember – your provider earns fees whatever the markets are doing. That goes for your work pension schemes, wealth managers or IFAs.
if your capital is being managed by someone else, read how to reduce fees by up to 80% by moving your money to cheaper (and better) self-managed funds and ETFs.
Inflation: There are many ways to hedge against inflation – read here
Taxes: Ensure you’re not paying taxes on your dividends, income and gains: utilise ISAs and Pension wrappers. If you have a business within a Ltd company, protect your profits from corporation tax by making employer contributions into your SIPP/SSAS (take advice from your accountant).
Earning Income (irrespective of market moves) …
Dividends Companies pay out varying levels of dividend yields but some blue-chip companies pay 5-8% pa. In the Investment Academy we show you how to filter higher yielding stocks using screening tools to select companies with strong balance sheets and solid profitability – to ensure dividend sustainability.
Options – Options can be used to earn cash income. Existing holders of stocks/ETFs can sell “covered call options” to earn additional income on their holdings that is paid whatever stock prices do.
Ways to PROFIT from the downside
Separate to buying equities, one can make money from markets going down. These are advanced strategies so be sure to have experience in them …
- Options to leverage to the downside (buy put options or put-spreads) – this makes money from down-moves
- Buy below current value by using options (using put options or selling covered call options)
- Earn options income to reduce your cost basis
Webinar Replay. We did a webinar last month, walking through several risk-cautious strategies that included:
- High Dividend stocks and ETFs
- Options for income
- Pound-Cost Averaging
- Low-Volatility ETFs
- Inflation Beneficiaries, including Commodities
- Balanced Funds
You can view the webinar if you missed it – link to view here. Password to view: ILAP27April
Most importantly – don’t panic. Remember: Historically, sell-offs have ALWAYS proved to be an opportunity to buy the world’s best companies on sale. Equally, don’t need rush out to buy all at once – patient Pound-Cost-Averaging is your friend.
Best Regards,
Manish
** Your Capital is at Risk ** This is not investment advice.
