Navigating Declining Markets

Contributed by Sani Hamid, Wealth Management Director, Financial Alliance Pte Ltd
(The contributor can be contacted at sanihamid@fa.sg)

Both the equity and bond markets have had a torrid first half to say the least.  

For the S&P500 itself, the first half of 2022 represented the worst 6-month start to the year since 1970.  

It wasn’t any better for the bond market as the Bloomberg Global Aggregate Index, which tracks the bond market in general, saw its worst ever performance based on data dating back to 1990 (see Diagram 2).

What makes this situation unique is the fact that both equities and bonds have fallen so drastically and in tandem, that it has left many portfolios exposed to double-digit losses on a year-to-date basis. Traditionally, a sharp sell off in equities would be cushioned by gains in the bond market or at the very least, smaller losses – but not this time round. For example, while the MSCI World has registered a first half performance of -21%, the Bloomberg Global Aggregate Index was down -12% over the same period, thus providing little relief for even a well-diversified portfolio.  

Given such a situation, what should investors do?

Stay Calm

While easier said that done, staying calm is really the first thing investors need to do. This is because very often, a panicked investor will make irrational decisions instead of executing well thought through actions. This is especially so when they believe that their portfolios are the only ones in negative territory.

For a start, understand that across the board, it is very likely that the majority of investors are in same boat. As mentioned earlier, given the sharp decline in both the equity and bond markets, even those who consider themselves as conservative investors would have experienced losses as a 100% bond portfolio would still have suffered a drawdown, unless it was totally in the money market or cash-type funds (which we suspect not many were, given the low returns these type of funds were offering prior to this year).    

What’s important now is to plan ahead on what to do under the circumstances.

Portfolio Adjustments

Next, the investor has to understand whether his/her portfolio has a higher risk than he/she can tolerate. How can this happen? At inception, investors typically enter when markets are calmer or even rising, thus inevitably providing them with a sense of relative security. While a risk profiling exercise is done to determine an investor’s risk profile, the answers given may subconsciously lean toward taking a bit more risk. This slight mismatch typically shows up in times of market stress when the investor starts to feel nervous and stressed out when his/her portfolio starts to decline.

So, if you are feeling this way now, it could be a sign of this mismatch. It is important to speak to your financial advisor. One action that can be taken is to lower the investor’s portfolio risk to better align with his/her lower risk tolerance. For example, this maybe in the form of moving from an aggressive portfolio, which has up to 100% equities, to a moderate portfolio, which has 50% equities and 50% bonds. And an added measure would be to ensure that the bond allocation is into bonds with lower volatility. Overall, this will bring down the portfolio’s volatility. For example, if the 50% equities were to fall another 20%, the portfolio should in theory fall by 10% (assuming that the 50% bond portion declines by 3% as it’s now invested in a less volatile bond segment).   

That is just one example of a strategy that can be taken. There are many other strategies that can be adopted, depending on the situation. For example, investors who strongly believe that markets will decline further could adopt a reverse dollar cost averaging strategy. There is also a barbell strategy for investors who strongly believe that certain parts of the market will do very well but want to take advantage of this in a measured manner so that the downside risk can be managed.

The glass is half full

Well, investment is a journey, and the path is seldom a straight line. Along the way, there will be sharp declines like the one we are experiencing now. That shouldn’t mean we should abandon this journey for fear of further losses. These are journeys typically tied to long term goals such as one’s retirement or providing for a child’s education.

Instead, such market volatility should be embraced as an opportunity to enhance the long-term returns of one’s portfolio. Warren Buffet is better than this than anyone else. His strategy is famously encapsulated in these famous words: “Be Greedy When Others Are Fearful, Be Fearful When Others Are Greedy”. In other words, one can see today’s volatility as the glass being half empty and adopt a pessimistic view of it. Or one can see this as the glass being half full where opportunities abound.

This makes a lot of sense when one understands that stock markets, over time, increase in value. The underlying reason is simple: owning equities mean owning part of the economy and thus, do economies grow over time? The answer is a resounding “Yes”.  If that is the case, then buying when stocks that are sold off during a crisis or recession will boost the returns of one’s portfolio greatly compared to buying when they are at fair value when they are overvalued.

The questions is, of course, how best to do so. For example, to dollar cost average or adopt different strategies such as the barbell strategy mentioned earlier. What suits you is best discussed with your financial consultant.

Summary

The apprehension and fear one feels under the present situation is normal. While the market’s volatility could remain over the coming months, what’s important is to not allow it to cloud one’s better judgment. Time and time again, investors have said “if only” when reminiscing about missed opportunities that crisis or recessions present. Work out a strategy with your consultant as to how you can take advantage of the present situation.  I will leave you with a famous saying which is very apt:

“The good times don’t last forever but neither do the bad times.”

Financial Alliance is an independent financial advisory firm that provides its clients with sound and objective financial advice to protect and grow their wealth. Providing top-notch services to both corporations and individuals, Financial Alliance is a trusted brand in Singapore and has been navigating its clients’ financial future for 20 years. For more information about Financial Alliance, click on the link.

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