As of Sept. 19, 2022
Although the U.S. economy has shown remarkable resiliency this year in the face of slowing growth trends, this is not the environment to be adding to risk more broadly, in our view.
Consider the landscape:
- The Federal Reserve’s attempt to cool demand across the economy through increasing rates doesn’t typically create great conditions for risk assets, from a historical perspective.
- Stickier components of inflation (i.e., services prices and wages) may linger at higher levels for longer, even though commodity prices have softened.
- With two consecutive quarters of negative U.S. GDP growth behind us, we expect below-trend growth in the U.S. over the next few quarters.
- S&P 500® Index profits are likely to trend lower in the front half of 2023.
With this backdrop in mind, investors should consider incorporating a few downside portfolio tactics into their investment strategy if they haven't done so already. Here are a few portfolio strategies we believe can help weather economic downturns.
1. Tactically shift stock and bond positioning toward the U.S.
The U.S. often acts as a port in the storm and can provide "relative" stability when uncertainty is higher or global growth conditions are slowing, as they are today. In our view, the U.S. is further along in its normalization process, the downturn here at home may be less severe relative to Europe/emerging markets, and the U.S. has a higher concentration of companies with more visible profit streams and secular drivers to growth. In addition, we expect the U.S. to be one of the key areas to lead the world out of an economic downturn.
2. Within stocks, focus on investment quality/income
Focusing on investments that concentrate on stable or growing profits, even when economic activity is shrinking, can provide relative outperformance versus assets more materially affected by a downturn. Notably, income generation tends to become a more prominent component of the return equation in a low or negative return environment. Defensive sectors such as utilities and consumer staples offer solid dividend-paying options, as do the financials, health care, and industrials sectors. Even technology can provide exposure to companies that are systematically paying and growing their dividend. But investors should be selective about the investments and companies they choose here and could tie the quality and income themes together to help add a defensive posture while maintaining equity diversification.
3. Don’t discount the value of diversification
A risk-based portfolio approach comprised of stocks, bonds, alternative investments, and cash often helps mitigate the slide stocks face in an economic downturn versus an all-stock portfolio. Unfortunately, stocks and bonds have come under pressure this year, reducing the diversification benefits of a simple 60% stock/40% bond portfolio. While this phenomenon is rare in history, declines across bonds have been less severe than equities this year. Also, alternatives and cash have helped add a layer of relief to a well-diversified portfolio. Taken in total, a diversified four-asset portfolio has typically lost less than the overall stock market this year and reduced volatility. We believe these principles should hold if economic conditions worsen.
4. For stability, look to high-quality bonds, which are becoming more attractive longer term
The 10-year U.S. Treasury yield currently sits at some of its highest levels dating back to 2011. Today, investors can lock in yields on a 10-year U.S. Treasury at a current rate we believe is an attractive yield for the more stable portion of a portfolio. Although the threat that rates may climb higher over the intermediate term remains a risk to bond prices, high-quality investment grade and government bonds can help reduce volatility in other areas of the portfolio (such as equities) while also helping focus on an income theme.
5. Consider alternative strategies
Sometimes a little flexibility can go a long way in helping a portfolio manage a downturn. Trusting good managers to make intelligent choices about allocating across assets, sectors, regions, and investment types allows a portion of your portfolio to be more responsive and dynamic in a volatile/uncertain environment. Alternative strategies that have responded well to a rapidly changing environment this year include Systematic Trend funds (e.g., price momentum strategies), Equity Market Neutral funds, Multistrategy funds, and Nontraditional Bond funds. The common thread across these strategies focuses on the manager's ability to respond more dynamically to shifting macro/micro trends driving asset prices over a shorter window of time. As such, these strategies tend to have more latitude in the size of their responses, which can help their fund quickly mitigate declines and/or take advantage of brief opportunities. We believe investors should consider utilizing these strategies in their portfolio, particularly when market volatility is high or economic conditions are deteriorating.
6. Stay disciplined, opportunistically use downdrafts to your advantage, dollar-cost average, and don't lose sight of your big-picture investment goals
The market will eventually start to price in a day where the Fed is slowing rate hikes, sticker components of inflation are declining, and economic/profit growth is on a more stable and upward-sloping trajectory. In our view, it's critical not to be capsized when the tide suddenly shifts and the boat moves in a new direction, which can quickly place investors on the wrong side of the ship if they're too defensive. The strategies described above should help investors avoid this scenario and be in a solid position to participate when the shift occurs. This can allow time for investors to modestly readjust their positioning back to a more neutral or opportunistic stance if appropriate.
Markets could remain volatile as long as growth is slowing/normalizing and interest rates are attempting to find a higher equilibrium level. In our view, there is an elevated risk that economic conditions could remain challenged over the next few quarters depending on the direction of a host of variables that remain very uncertain currently.
Yet, we believe assets have priced in some of the pain from higher rates and slower growth, given stock prices attempt to discount the future. As such, we believe investors should avoid becoming too defensive or skewing their portfolio materially away from longer-term asset allocation targets — which are designed to weather multiple market/economic cycles.
Have questions about the above portfolio strategies?
Your Ameriprise financial advisor will answer any questions you may have and can provide personalized recommendations to incorporate some or all the strategies described above. They have the tools and resources to help you employ a dollar-cost-averaging strategy and find ways to use economic/market downturns to your advantage (e.g., tax-loss harvesting).
Data sources for indices and sector graphs: Morningstar Direct, as of Sept. 9, 2022
Past performance is not a guarantee of future results.