World stocks’ difficult first half of 2022 has continued in June amidst a cavalcade of concerns, evoking a constant drumbeat of headlines we read warning of worse to come.[i] In these trying times, the urge to do something may seem overwhelming—but doing something can easily backfire. In that vein, here are some dos and don’ts we think can help you in difficult times like the present.
We know market downturns can be hard—and frightening. Enduring one is far from ideal, in our view. When one comes amidst a series of seemingly relentless negative news stories, cutting equity exposure may feel like the sensible and prudent thing to do: Take your losses and live to fight another day. In our experience, though, that isn’t necessarily wise, as selling crystallises declines into losses and increases the chances you miss the recovery—the chance to recoup those declines. Hence, our first recommendation.
Don’t panic. When all seems lost, we think it is best to stay calm and collect yourself. First, assess your situation. Ask: Is my portfolio’s asset allocation (the mix of stocks, bonds, cash and other securities) designed with market downturns—even bear markets (typically lasting, fundamentally driven declines exceeding -20%)—in mind? Meaning, are the expected long-term returns it is based on inclusive of bear markets? If so, we think it is important to remember the returns this allocation plan hinges on include rough times like the present—or even worse. Mitigating bear markets’ drops may be nice, even beneficial, but we find it isn’t necessary to obtain equity-like returns over time.
Do look forward. We don’t think anybody knows exactly when the ongoing downdraft will end. In our view, inflection points are impossible to identify until well after the fact—but our historical research shows bull markets (prolonged periods of overall rising stock prices) have always followed bear markets, the recoveries are usually strong, and stocks typically continue on to even higher highs than before the bear market. We think the key is to participate in the upswings when they come. In our view, reacting to past downside risks locking in the decline—which then necessitates timing a re-entry very well. That is tough to do, in our experience, considering successfully exiting and re-entering would require you to buy when markets are lower, which in turn requires: a) them to fall further and b) you to have the gumption to buy when things look even worse than now. We find market recoveries are typically very strong and start when very, very few expect them to. We suggest trying to envisage that now.
Don’t chase heat. Besides going to cash, the other bear-market temptation we have observed is to chase the downturn’s winners. In this period, the Energy sector is the clear standout. Since the MSCI World’s high on 8 December, Energy is up 32.5% versus global markets’ -14.0%.[ii] But through 8 June, Energy had risen 59.0%, benefitting from many of the perceived negatives that have plagued stocks generally this year—like persistently high oil prices, which can aid the sector’s profits.[iii] Since then, Energy has declined -16.7%.[iv] We think this, too, is sentiment-driven, reflecting fears of a recession (extended widespread economic contraction) destroying demand. Whilst a recession is possible, despite sentiment otherwise, we don’t think it is likely. But if that changes and one does arrive, we think Energy stocks would likely do quite poorly due to their sensitivity to economic ups and downs. Recessions tend to destroy demand for energy, which knocks oil and gas prices—reducing Energy producers’ earnings.
Do maintain liquidity. We would also suggest avoiding illiquid assets—things that can’t be sold easily without affecting the price. For example, take private equity (unlisted ownership shares not traded on public exchanges) and collectibles (such as art, antiques, classic cars and vintage wines). We think such investments can be especially dangerous because although they might appear to be doing well or holding up, that may be illusory. Because they don’t trade often, their prices may be stale—not reflecting current market conditions—or be subject to dodgy pricing generally, using incomplete methods to gauge their current worth.
Do steer clear of flashy sales pitches. In a similar vein, we have found products and services that prey on bearishness often abound during market downturns. Low-volatility or inverse (and leveraged) exchange-traded funds may top performance leader boards this year—and we have found they are often advertised that way—but that is just another form of heat chasing, in our view.
Don’t dive into dividends. To be clear, although we have nothing against dividends, we think chasing stocks for their dividend yields alone is far from a sure-fire strategy during rocky markets. Remember, dividends are a return of capital, not a return on them. When paid, the stock price drops by the dividend’s amount—this is how the maths work. People often see the dividend payment as a cushion, in our experience, but in doing so they can ignore that dividend stocks are also subject to price movement. Reinvested dividends are but one part of total return, and dividend stocks aren’t always outperformers during downturns. Moreover, dividends can get cut—and we find they often are at the worst possible time, deep into a downturn. We have noticed it can also lead to overconcentration in sectors and industries, negatively impacting diversification and, therefore, increasing risk.
Do remember that, in our experience, the low will likely be clear only in hindsight. Even amongst broader bear markets that continue on to lower lows, sharp rallies can come. We think getting caught up in relief on a rally is as much an error as despairing during a renewed drop. As always, past price changes—down or up—don’t say anything about future ones, and short-term moves say less. We find adjusting your expectations to keep an even keel and looking longer term is better than riding emotional waves from moment to moment. In our view, time, perspective and a level head are an investor’s best tools in rough market stretches.
[i] Source: FactSet, as of 23/6/2022. MSCI World returns with net dividends, 31/12/2021 – 16/6/2021.
[ii] Ibid. MSCI World and Energy returns with net dividends, 8/12/2021 – 22/6/2022.
[iii] Ibid. MSCI World Energy returns with net dividends, 8/12/2021 – 8/6/2022.
[iv] Ibid. MSCI World Energy returns with net dividends, 8/6/2022 – 22/6/2022.
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