Two Steps Forward, Two Steps Back

By Paul Morrone, CFP®, CPA/PFS, MSA

Uncertainty is the name of the game in 2022 as investors make bets as to how quickly the Fed will have to continue its tightening policy in the face of stubbornly high inflation. Short lived equity rallies in March and May have seen gains quickly wiped out as the news cycle churns out headlines and investors react. For the past few months, the S&P has danced with what’s known as a bear market – defined as a 20% pullback from a high point. While we have traded below this threshold, the official definition of a bear market specifies that the index must close 20% or more below its high – a line in the sand that was finally crossed on June 13th, 2022. From a practical perspective, this is no more than semantics as market technicians must draw the line somewhere in creating definition of what actually defines a bear market. In reality, there is not much difference when the index trades at 18% or 22% below it’s high.  Regardless of whether stocks are in bear market territory or not, many are wondering what may be going on behind the scenes in their portfolios as we start to digest some of the most recent headlines. 

Some key take aways from our past communications will no doubt reflect consistent messaging. The long-term nature of our investment philosophy and portfolio construction means that we will not take outsized bets on the market moving one way or the other. Similarly, we will not make outsized bets on one company, sector, or geographic region as we believe that maintaining a disciplined and diversified portfolio will provide our clients with the better and more predictable long-term outcomes. That does not mean, however, that we don’t make strategic tilts in our portfolios that we hope will generate some alpha over the short term but will not result in material deviation from expectations over the long term if we make the wrong call. Below is a broad summary of some of the tactics that we’ve implemented this year. 

•    Loss harvesting: While we may not be able to control the direction of the market, we can help to control the tax burden that investors may face with respect to their portfolio income. We’ve realized capital losses across virtually all taxable client accounts, which should provide most with deductible losses that they can capture on their 2022 tax returns. Importantly, loss harvesting doesn’t mean that we convert funds to cash and lock in losses, as we will use the proceeds of a security sale to immediately buy back into a nearly identical position so that we aren’t sitting on the sidelines. 

•    Increasing cash allocations: Typically, cash allocations have been nominal within our portfolios. We’ve opted to increase our cash position – temporarily – by roughly 2-5% depending upon investment objective. This provides additional flexibility should you need portfolio distributions and/or give us the ability to deploy additional cash when an opportunity presents itself and when we feel we have a bit more clarity as to where an opportunity may exist.

•    Rebalancing: As equity prices remain depressed and fixed income allocations stabilize, we have seen some opportunities to rebalance portfolios and ensure that our allocations remain aligned with expectations. Doing so in times of volatility ensures that when markets do rebound, that equity allocations remain on target and that we are not significantly under or overweight any one asset class. 

•    Reducing growth exposure: A longtime bias or overweight in our portfolios has been in growth equities. This asset class has significantly outperformed value equities over the past 10 years and has been one of our strongest performing positions coming into 2022. Growth stocks tend to be much more price sensitive to changes in interest rates, which is why they have suffered far steeper declines in 2022 than their value counterparts. In anticipation of this, we have reduced our direct exposure to growth stocks by roughly 1-3%. This has created a more neutral growth/value stance in the portfolios which we feel is better aligned with our outlook for the future.

•    Overall note: Not all stocks or bonds are created equal. Just like various tools in a toolbox offer different types of utility, so do the securities in the investible universe. If you’ve monitored some of the trading over the past few months, you may have noticed that we have added or eliminated certain securities. This is by design. These subtle changes allow us to tweak exposures or exhibit bias in favor of certain type of stocks or bonds – growth vs value stocks, as an example. However, you should not have noticed a change in your high-level allocation – 60/40, for example – as we will continue to maintain our stance that time in the market is more important than timing the market. 

It is also important to highlight the fact that none of these tactics are designed to eliminate volatility or deliver substantial market beating returns. They are small measures that we hope provide short-term benefits as we believe volatility will persist in the near future as markets and investors continue to digest new information about inflation, supply chain disruption, energy prices and the Fed’s interest rate hikes on a daily basis. 

To be crystal clear, we are not bearish on stocks as a long-term investment and still maintain a healthy allocation to equities across all investment objectives. Especially considering the current inflationary and rising interest rate environment, stocks offer a very attractive value proposition for long-term investors. If you have any questions, please do not hesitate to contact us to discuss your personal situation. 

_{The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.
The content is developed from sources believed to be providing accurate information.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss. 
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