The proximate cause of the early February sell-off was fear of higher interest rates in the US, stemming in part from data pointing to increases in average hourly earnings. However, this may only tell part of the story. The sell-off may also reflect the expected drag that higher yields and tighter monetary policy could have on the economy.
This is highly problematic for stocks, not simply because earnings should correlate to economic growth, but because in the afterglow of US tax reform and fantastic forward earnings guidance, stocks had priced the economic environment to perfection. In other words, stock valuations were high based on optimistic expectations for future earnings. Perfection is a high bar. Timing the market is always impossible, but this sell-off was coming – almost to be expected – we just couldn’t know when.
Bullish and bearish soundbites abound in equal measure. Depending on who you listen to, we are either at the start of the next market bust or experiencing a brief correction before the bull rides higher. So what’s an investor to make of all these conflicting signals?
During periods of confusion, it can be helpful to revisit some basic investment virtues. With that in mind, here are 15 ideas to fall back on when the outlook is uncertain.
Patience#1: Put time on your side
Security prices rise and fall throughout cycles, so many investments offer a decent chance of success if held for the right time period – or for the duration of the cycle. The only question is whether you will have the conviction to hold on long enough to see the profit.
#2: Ignore the daily drama
Market activity in the short run is mostly noise and random volatility, but investment goals are generally long-term. Do your best to ignore the news of the day and focus instead on more enduring trends and developments.
#3: Don’t be sidetracked by “end of the world” predictions
Broad stock market indexes like the S&P 500® have historically gone up over time: gains are more frequent than losses. As a result, you don’t need a strong reason to be bullish, but should have a good reason to be bearish, because the odds are not in your favor.
Humility#4: Don’t be too sure…
In this business, there is no such thing as proof. Investing is by definition about the future, which is uncertain. All data we evaluate is evidence that leads to some probabilistic estimate. This evidence, however, is not proof that anything will or won’t happen.
#5: Avoid never and always
Investing is a probabilistic endeavor (see #4). As a result, the words "never" and "always" shouldn’t be part of an investor’s vocabulary. Policies, perceptions, and prices are in constant flux – there is no “sure thing.”
#6: Look at the bigger picture
Investing is closer to art than science. “A” doesn’t always lead directly to “B”, so be careful not to extrapolate a single idea into a world view. Market information should create a mosaic where individual pieces can be viewed in a larger context.
Thrift#7: Buy low, sell high
While there are dozens of factors to consider, valuation is an essential component of investment selection. Is the asset cheap or expensive? You can’t control the price at which you sell, but you can control the price at which you buy.
#8: Penny wise, pound foolish
Cost is important – especially as it directly offsets returns – but value for what you pay is more critical. This is obvious everywhere but in the investment business. Sometimes investment quality is worth a few extra basis points.
#9: Keep an eye on taxes
Focusing solely on minimizing taxes may not be the best investment strategy. The goal is to generate investment income and capital gains – which comes with the burden of taxes. The key is to minimize unnecessary taxes and keep as much as possible. Consult with a tax professional, and remember that rebalancing may have tax consequences.
Diligence#10: Don’t chase past performance
Investment selection predicated largely on recent performance is doomed to fail. Usually you're just buying a lucky manager or a hot asset – and all streaks eventually come to an end.
#11: Stop looking for the silver bullet
Don’t waste time looking for an investment panacea. Everything comes with risk and no product is right for every situation. If such an investment did exist, we'd all own it already.
#12: Personalize your portfolio
Investing is the interplay between dynamic markets and unique individuals and institutions. An effective solution should address each investor’s circumstances, risk profile, and available opportunities. One size doesn’t fit all.
Prudence#13: Win the "loser's game"
It is often said that investing is a loser’s game – a game with the outcome determined by who makes the fewest errors. Limiting investment mistakes is probably more important than getting everything right. You can “win” by not losing too much or too often.
#14: Know your pain threshold
The starting point for portfolio construction is risk, not return. In the long run investors might get paid for taking on more risk, but they’re unlikely to realize those returns if they’re frightened out of positions and sell at the wrong time. A candid evaluation of risk tolerance can help avoid a portfolio that’s too hot for an investor to handle.
#15: Keep it simple
Perhaps to justify fees or salaries, the investment business gravitates toward complexity – in explanations, theories, products, and math. But remember Occam’s Razor: Don’t make things more complicated than they need to be. Buy low, diversify, rebalance, and keep an eye on expenses and taxes.
Important Risk Considerations
All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. Diversification does not guarantee a profit or protect against a loss.
Investment decisions should be based on an individual's own goals, time horizon and tolerance for risk.
Natixis Investment Managers does not provide tax or legal advice.
The views and opinions expressed may change based on market and other conditions and are as of February 12, 2018. This article is for informational purposes only and should not be construed as investment advice. Any economic projections or forecasts contained herein reflect subjective judgments and assumptions, and unexpected events may occur. There can be no assurance that developments will transpire as forecasted. Actual results may vary.
S&P 500® Index is a widely recognized measure of U.S. stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors. It also measures the performance of the large cap segment of the US equities market. You may not invest directly in an index.
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