Q1 2022 Quarterly Newsletter
This past quarter was marked by volatility not seen in quite some time. During this first quarter the US Stock Market was down 5.28%, International Developed was down 4.81%, Emerging Markets down 6.97% and the US Bond Market was down 5.93%. Somehow it feels different than the Covid-19 volatility from two years ago…This volatility feels like it’s coming from all directions. Building inflation, raising interest rates, a brutal war in Ukraine, rolling Chinese lockdowns…These big headline risks continue to cause indigestion to investors, who are, on one hand, sitting on historic amounts of idle cash, and on the other, saying “things seem scary right now.”
And who could blame them? Years of profligate spending by Congress and low interest rates set by the Federal Reserve seem to have come to a roost, with Fed and Treasury officials finally admitting that inflation may not be ‘transitory’ after all. The US, and to a lesser extent the World, has been awash in cheap money for the better part of a decade…what did we expect? The extent to which inflation is caused by a jammed up supply chain is debatable, but it certainly isn’t helped by the fact that China, the world leading manufacturer, is locking down its citizens and temporarily closing factories, further limiting supply. Russia’s invasion of Ukraine has caused energy markets to go haywire and is requiring a difficult balancing act by worldwide leaders to ensure WWIII doesn’t break out.
Our path forward amid fear
By now we know that it’s a fool’s game to try to time the market, which includes market timing’s cousin “tactical allocation” (shifting allocations based on anticipated future events). We believe a better way is to build and maintain evidence-driven portfolios that focus on 5 key factors
Global diversification - Any one country can experience long periods of underperformance (think Japan over the past 30 years) but when we spread out our investments over literally thousands of companies in hundreds of countries, we limit the exposure to any one country or company.
Modest small and value tilt - Small companies tend to have more control over pricing and can respond quicker to rising costs, which is important during periods of high inflation. Value companies, including the financial, consumer staples and energy sectors, can help provide diversification as banks make more money with higher interest rates, consumer staples tend to maintain demand in economic downturns and energy has historically performed better relative to the overall market during inflationary times.
Minimize credit risk and keep maturities short - Investing in high-quality US and corporate bonds decreases the risk of default relative to more speculative, lower grade junk bonds. Staying high-quality decreases bond price variability and adds to the ballast of the portfolio. Bonds are very sensitive to interest rate changes and the longer out you loan your money the more volatility in prices you experience. Staying short dampens this volatility and adds to the ballast of the portfolio.
Use institutionally managed asset class strategies - Few investment providers today truly have the best interests of the investor in mind. A few of the ones we trust are Dimensional Fund Advisors, Vanguard and iShares.
Invest in a tax-and-expense-conscious manner - There are only three things that we can control when it comes to investing…Our behavior is the first, and the other two are the taxes and expenses we pay. It’s of paramount importance to be mindful of the impact of taxes and expenses on a portfolio.
In Closing
Simply reading about scary things does no good. We need actionable steps to take to achieve our goals. We need a framework to help guide decisions through turbulent times that limits emotions and keeps us moving in the right direction. Our goal at Thomas Financial Advisors is to create and maintain that framework together.
-Andy