Navigating a volatile market: Ways to turn choppiness into opportunity this year
By David Kressner, CFA, CFP®
Managing Advisor, Altfest Personal Wealth Management
Many of our clients at Altfest Personal Wealth Management, where I work as a managing advisor, have come to us with questions and told us about sleepless nights from monitoring their portfolio statements in recent months. For many investors, 2022 was a very eventful, and frankly disappointing, year for the economy and the markets. To understand the reasons why, and to prepare for possible continued market volatility this year, I think it’s important to review 2022 in the context of the last few years.
What made last year so tough?
First, governments around the world unleashed massive amounts of fiscal and monetary stimulus at the start of the pandemic in early 2020. On the fiscal side, you’ll remember stimulus checks, enhanced unemployment benefits, the Payroll Protection Program, or PPP, for small businesses and many other initiatives. In terms of monetary policy, the Federal Reserve in the U.S. and central banks around the world used all the tools at their disposal to get interest rates as low as possible.
The goal of these combined efforts was to help the economy recover from the largest downturn since the Great Depression, triggered by the restrictions imposed during the pandemic. And these efforts were rewarded when a huge jolt to the economy was delivered and the pandemic recession became the shortest on record — lasting just three months.
Unfortunately, the aftereffects of these policies have been exacerbated by geopolitical tensions and other issues that hit global economies in a toxic brew of concern and uncertainty. The most noticeable of the economic stimulus aftereffects has been elevated levels of inflation that we haven’t seen in 40 years or more.
To cool this overheated inflation, the Federal Reserve increased interest rates from nearly 0% at the beginning of the 2022 to a targeted interest rate of between 4.25% and 4.5% by the end of the year, which is the highest level in the last 15 years. In early February, the high end of the target fed funds rate is 4.75%; a year ago it was 0.25%. This rapid sequence of increases is the most aggressive policy move by the Fed since the last bout of very high inflation back in 1980s.
The Fed has indicated it expects to keep interest rates at these elevated levels until inflation is under control, which may mean no interest rate cuts until 2024.
The story is far from over, and it’s good to remember that off years are always part of investing. We’re still dealing with the same economic headwinds that caused last year’s market volatility and sharply lowered values for most types of investments, including those traditionally considered safe and the bedrock of a diversified portfolio.
What can you do now?
To be best prepared for more volatility this year, let’s look more closely at some smart ways you can protect your portfolio.
Preparing for a bumpy 2023
We at Altfest think you should be defensive where it makes sense, and offensive where you’re rewarded for being offensive. That’s what we’re doing in the portfolios we manage. Let me give you some quick examples of our thinking now.
Normally, bonds have been considered a tad boring. But, suddenly, that’s not the case. We think bonds are an interesting place to be in early 2023. Although we were negative on bonds this time last year, today you’re getting higher yields and we think that bonds are a good hedge and protection in a rougher economic environment. When there’s a recession, interest rates tend to fall and, in anticipation of the Fed decreasing rates and a slower economic environment, there’s a flight to safety. In this climate, bonds ultimately can do better than stocks.
With that in mind, there are certain bonds we like today. For example, long-term Treasury bonds and bonds that are 20 years or more in maturity. They can benefit the most from a declining interest-rate environment. We see the economy slowing, and the strong possibility of a recession in the near future will cause interest rates to go down further.
We also find mortgage-backed bonds attractive, as they deliver good yields today. Also think about Treasury Inflation Protected Securities, or TIPS. These are government bonds that give you more money back as inflation increases. So they can do better in a higher inflationary environment, like the one we have now.
When it comes to stocks, we are avoiding more cyclical parts of the stock market, those companies whose performance tends to fluctuate in line with the economy and are economically sensitive. Some examples of cyclical stocks would be banks and industrial companies. We prefer more-defensive companies, in sectors like health care, companies whose cash flows are more stable because there’s always a demand for their services — even when the economy is weaker.
You might also consider international companies for 2023. While international markets over the last few years haven’t been a good place to invest, now the prices for companies outside the U.S. are much more reasonable. We actually have close to 40% of our stock allocation outside the U.S. More than half of that is in developing, or “emerging” markets.
In particular, we are invested in Asia and China among emerging markets. We believe China’s reopening after tough COVID restrictions is going to be a growth driver for other economies, close trading partners of China such as Europe. Although China and these other emerging markets certainly aren’t without political and economic risk, we think if invested in an informed and thoughtful way, the valuations there right now are so compelling it’s really a risk worth taking. With Asian investments, for instance, we get growth companies at value, or bargain, prices, which we like for positioning right now in client portfolios.
Beyond stocks and bonds, amid the last year’s bumpiness we’ve taken money and put it into alternatives, which means less-traditional assets such as real estate, hedged equities and commodities, among others. At Altfest, we have more than 20% of our client portfolios in alternative investments today. Specifically, we favor alternative investments that keep up with inflation and those that are reasonably priced. This type of alternative investment can zig when the rest of your portfolio zags, so to speak. These holdings deliver very good diversification benefits.
Our objectives with alternative investments are achieved through our in-house strategy, called Alternative Alpha, or, for example, by buying into hedged equities that allow you to manage the risk on the downside, almost like a form of portfolio insurance. With hedged equities, along with downside protection you get some participation on the upside but not as much exposure as if you were directly investing in the markets.
Another approach to consider under this category is infrastructure investing. At present, we are attracted to utility, railroad and toll-road companies. They have more predictable cash flow and tend to be less economically sensitive, often as a result of their long-term contracts. We know there’s been an underinvestment in infrastructure in our country for quite some time, so there’s a growth aspect to this area, to be sure. The return of infrastructure investments comes both from appreciation and income generation through yield payments to our clients.
Last, we are invested in private real estate and offer that to clients when appropriate, given their financial circumstances. We focus on buying private real estate in a fund for clients because this asset has been a good inflation hedge and provides diversification by not always moving in tandem with stock and bond prices.
Your plan for navigating volatile markets
As you can tell, at Altfest we think there are myriad opportunities today, even if the markets look frightening. Now is not the time to do nothing with your investments – nor should you exit the markets when spooked by economic conditions. Instead, we advise you to take advantage of these openings, constructing your portfolio in new ways that make sense amid today’s unpredictability and risks to reap the most potential rewards.
Find out more
We’re here to help you navigate volatile financial markets. We realize each client or potential client’s situation is unique, so we encourage you to reach out to our firm with any questions you may have. Altfest advisors are ready to evaluate your current portfolio allocation or to help you start investing advantageously for the first time.
If you’re not yet an Altfest client, please book some time for a complimentary consultation