Why we’ll need an all-weather portfolio going forward

3 August 2022

Chris Miles, head of UK Financial Intermediaries at Capital Group, considers how paraplanners should look to prepare client portfolios as we head ‘into a period of real change’.

We are living through a pivotal time in history, marked by geopolitical realignment, high inflation, volatile financial markets, and the end of a 40-year period of declining interest rates. A lot of current events rhyme with the past, particularly the early 1960s when we saw interest rates bottom out after decades of decline, as well as the rise of the Cold War era, which is unfortunately rearing its head again in some respects.

Despite these challenges, we remain optimistic about the investing environment for the following reasons:

1. There are still signs of growth as the global economy recovers from the pandemic.

2. We believe corporate earnings will be the driving force of equity markets going forward, as opposed to multiple expansion, and that signifies a welcome return to fundamentals. Multiples needed to contract, and that is what we’ve seen over the past few months.

3. We are likely to experience a healthy recession in the next year or two. We use the term ‘healthy’ because despite all the concern from market participants, a moderate recession is necessary to clean out the excesses of the past decade. You can’t have such a sustained period of growth without an occasional downturn to balance things out. It’s normal, expected and healthy.

“We are likely to experience a healthy recession in the next year or two.
We use the term ‘healthy’ because despite all the concern from market participants, a moderate recession is necessary to clean out the excesses of the past decade”

What this means for stock markets

We are heading into a period of real change, a fundamentally different marketplace where different leadership will emerge. That’s in sharp contrast to the 2020 COVID-19 downturn, which was really just a temporary blip in a decade-plus bull market. We know this because the same stocks that led the bull market — a relatively small group of tech-related companies — did so on the way back up.

In a true market shift, the leadership coming out of a bear market is usually a new sector or a new group of companies. And it’s not necessarily the same group that led on the way down. For instance, in the current environment, energy stocks have staged a remarkable rally, but we don’t believe the energy sector is going to drive the next bull market.

That said, going forward we think it’s likely going to be a very different market. Even though we wouldn’t count out the FAANG (Facebook, Amazon, Apple, Netflix, Google) stocks, we believe the market won’t be driven by a small set of stocks anymore. It won’t be characterised by growth vs. value, or one economy, for example the US vs. the rest of the world. Those binary concepts will increasingly become redundant in this environment and the market will instead be less one dimensional. We expect a broader mix of stocks to lead us out of this downturn.

What this means for bond markets

We are also seeing a profound shift in bond markets as we reach the end of a 40-year path of falling interest rates. Sharply higher inflation levels, not seen since the 1980s is forcing central banks to aggressively tighten monetary policy, with rates likely to continue increasing.

However, that doesn’t mean we are going back to exceedingly high inflation and interest rates. It just means that, for decades, we have lived in a declining rate environment that has been highly supportive of markets. Although the road ahead is bumpy, the broad credit universe provides ample opportunities for investors to add value through bottom-up research and security selection in each of the four primary credit sectors – high yield, investment grade, emerging markets and securitised debt.

Lessons from the past

During this time, it’s important to remember that higher nominal interest rates are good for savers. This is a novel concept for younger adults, but boomers grew up in a world where interest rates were sufficient to earn a decent return on savings accounts and money market funds. That’s a positive change, as it makes people feel better about saving.

Over time, higher rates will also bring income back to the fixed income markets — something that has been sorely missed in the era of easy money. The importance of that shift cannot be overstated, as it should eventually restore bonds to their rightful role providing diversification from equity risk.

Along those same lines, some inflation is actually a good thing. It allows well-positioned companies to raise prices, and it results in generally higher wages. That makes people feel better about their jobs and progress. It is hard to predict what will happen to real purchasing power, but we have seen in the past decade that without a little inflation, people feel like they’re not getting ahead.

Maintaining a balanced, “all-weather” portfolio makes sense in any environment, but particularly this one. Market volatility has returned, but investors should not be discouraged. Indeed, the world has changed dramatically. But, for selective investors, change creates opportunity.

At Capital Group, our fundamental, bottom-up investment approach leaves us well positioned to identify specific companies that can generate strong earnings growth. We remain confident that we have the right people in place making decisions based on deep, company-specific research, which has always formed the basis of our long-term investment philosophy.

Professional Paraplanner