As the New Year approaches, it’s a healthy exercise to evaluate the year that’s ending and look ahead to the next one. Here we offer a collection of insights our BlackRock Portfolio Solutions team has gathered from working with thousands of advisors on close to ten thousand investment models in the past twelve months. We hope you find the look back and the look ahead helpful.
2 things we learned in 2018
1. Corrections still happen
Entering 2018, it was easy to forget that markets actually can and do go down. The S&P 500 had held below its long-term average volatility for the previous six years, and hadn’t dealt investors a 10% decline in almost two years. In 2018, we saw two such corrections – the first beginning in late January and the second in early October. The first was hard to react to. It lasted only nine days, and quickly reversed as the market reached new highs in the subsequent months. Advisor models weren’t defensively postured entering the year, and it turns out they didn’t need to be for that first correction.
The second correction was more significant–not in magnitude but in the way it eroded confidence. As the year ends, we notice that, compared to earlier in the year, advisors are more concerned about global trade issues and less certain about where we are in the market cycle.
In the past, our stress test analysis of all ten thousand models suggested advisors had client portfolios well-positioned for further economic growth (the right call), but not well-positioned for a recession. If the collective views of the advisors we work with are shifting, we should expect advisor models to demonstrate that change. While we’ve learned that corrections do still happen, we haven’t seen much evidence that advisors are doing much about them….yet.
2. Cash can actually produce yield
A key story line this year has been the rise in yields of short maturity bonds and cash-like instruments. However, although the inflation-adjusted yields on short maturity bonds are positive for the first time in years, they are still not likely enough to sustain most investors in the long run.
Considering bond portfolios in isolation, advisors are right to shift into shorter maturity bonds, which now yield almost as much as longer maturities do. We do find short-term bonds attractive today, and the increased yields now available offer a buffer in case rates continue to rise. However, almost every model in our data contains stocks, and the decisions you make in managing bonds in isolation are different than those you make while also managing equities. As we approach the ninth rate hike into a Fed tightening cycle, we believe investors can be a bit less concerned about losing money in bonds, and a bit more comfortable adopting a conventional view that bonds can diversify the risk of your stocks falling.
2 things we’d do in 2019–A potentially more difficult year
1. Get properly diversified
If the corrections of 2018 remind us of anything, it’s that we cannot ignore the importance of diversification in building resilient portfolios. We likely need to own some (not necessarily a lot) of what makes us uncomfortable; this is where real diversification comes from. Ask yourself, “If the markets moved in the opposite direction from the way I think, will any of my investments do well? If you feel good about everything in your portfolio simultaneously, then you aren’t likely well-diversified.
At a minimum, re-balancing your portfolio should help. However, considering that the market environment may be shifting, re-allocating your portfolio may be what’s needed. This is not to suggest shifting assets from stocks to bonds, nor going to cash – your long term asset allocation is critical to reaching your investment goals. Rather, it may be time to consider owning different things within the stock and bond sleeves, particularly things that improve the diversification of each sleeve or the portfolio as a whole.
2. Manage investing emotions
The more volatile the market events, the more emotive the human response. Successful investing avoids emotional overreactions to any one bad day, bad monthly statement, or a poor result from a bad stock pick. Turning off the television can help.
Try to envision a larger picture. There have always been volatility spikes in markets, and there likely always will be. Successful investors understand how to navigate the emotions that come with them.
Preparation is important. If you suspect the market environment may be shifting in the coming year, simulate that now, and decide what things you plan to add to the portfolio (along with the things you plan to remove). If you can, stress test both portfolios to ensure your changes will give you the shift in outcomes you seek.
If market volatility starts to make you nervous, ask yourself an important question; “Am I bearish or am I uncertain?” Don’t confuse the two. If you are bearish, then make the portfolio more conservative. But if you are uncertain, then don’t make big bets in either a bullish or bearish direction. Importantly, uncertainty should lead your portfolio weights back to your strategic asset allocation–not to cash.
Being under-risked can be as problematic as being over-risked. There’s no reason to be either while you are under-confident.
As we prepare for the ball to drop in Times Square, it’s a great time to take stock of your portfolio. At moments of uncertainty, it’s important to simplify your process, reduce the size of your bets, and don’t get hung up on the last 10 years as if it’s the only type of market that can exist.
Shifting your focus to regimes–not weeks or months–can allow you to stay nimble, play defense if needed, and capitalize on the next market environment as it begins to develop.