January marked the worst start to the year for the S&P 500® Index since the global financial crisis of 2007-2008. Investors confronted a dynamic mix of United States Federal Reserve (Fed) tightening, elevated inflation, geopolitical tensions, and softening economic growth.
While short-term market pullbacks are normal and inevitable, many investors are concerned about what these fluctuations might mean for the year ahead.
With periods of sharp volatility likely ahead, navigating an investment environment “past the peak” will require a much more discerning approach from investors.
Here are four factors to consider:
Quality: Over the past two decades, quality factors have tended to outperform during periods of slowing growth and deteriorating market conditions, which are expected in the coming months. Companies classified as Quality emphasize earnings stability, margin sustainability, and balance sheet strength. Pricing power also tends to be strong.
- U.S. outperformance: Emerging markets traditionally struggle most when liquidity conditions tighten. During the 2013 taper tantrum, while U.S. markets promptly recovered, emerging markets plunged into a prolonged decline. Additionally, as a net exporter of oil, the U.S. economy is less vulnerable to a rise in energy prices.
- High yield: The U.S. high yield market presents potential opportunities in fixed income in 2022. Not only is its shorter duration profile preferred in a rising rate environment, but the fundamental outlook remains solid. As the asset class is generally of higher quality than ever before, default rates have dropped and are expected to remain below 2% this year. In the period ahead, we believe positioning fixed income portfolios to earn returns from alpha, rather than from spread compression or duration, will be key.
- Alternatives and privates: Current equity and fixed-income valuations are increasingly correlated. Exposure to alternative or private investments to maximize diversification may allow higher expected returns for equivalent risk levels or equivalent expected returns with lower risk levels. Real assets such as infrastructure, real estate, natural resources, and commodities, or private asset classes such as farmland, timber, and commercial real estate, can provide diversification, while offering greater inflation sensitivity and higher income potential.
Despite the underlying economic support for risk assets, there still remain significant challenges ahead. However, we believe opportunities do exist. Particularly for companies that can lean on resilient consumer spending, strong corporate balance sheets, and gradually improving global supply dynamics.
Navigating an investment environment that is “past the peak” will likely require a much more discerning approach from investors. In the period ahead, consider reaching out to your financial advisor — they can review your portfolio with you and help you remain on track to reach your financial goals.