The S&P 500 has tumbled close to 20% since its peak, bringing it close to bear market territory. Inflation concerns, a hawkish Fed, rising interest rates and US Dollar strength has contributed to a broad decline in risk assets from equities, cryptocurrencies and even bonds.
Understandably, there are concerns from investors looking to invest in this current macroeconomic conditions. Most growth focused ETFs and stocks have fallen dramatically from their peak. The glorified ARKK ETF by Cathie Wood is 70% down from its peak and close to 40% below pre-pandemic levels. Most indices are also down below pre-pandemic levels as well.
Is a recession coming? Maybe a technical one, defined as two consecutive quarters of negative GDP, might occur. The economy is relatively strong with post-pandemic recovery on the way. Job vacancy is still healthy and prices of properties are still rising.
However, prices of assets have fallen in response to the rising interest rates. The 10-year US treasury bonds are now yielding close to 3%. Singapore Savings Bonds are now yielding 2.53%. All these puts pressure on market valuations.
The most important rule is to survive
Surviving the bear market is critical – you don't want to have your portfolio wiped out in this market.
This means it's critical to avoid massive portfolio drawdowns – a 20% portfolio drawdown requires 25% returns to breakeven, while a 50% drawdown requires 100% returns to breakeven.
Realistically, it's difficult to get 100% returns over the next several years if the macroeconomic environment does not improve. Hence, you don't want to over-leverage or over-invest in high beta stocks and ETFs in this market.
Many investors are always 100% long the market, i.e. they are always buyers of stocks and ETFs and never sellers. This is a good habit to cultivate and rewards long-term investors handsomely over multiple decades.
However, hedging can help reduce portfolio drawdowns, improve time-to-recovery and offer better risk-adjusted returns. For example, investors can consider buying put options, purchase an inverse ETF, commodities or energy equities or even hedge with USD given its role as a safe haven when markets turn bearish.
Some of these are complicated investment instruments, but they help calm nerves when the losses in your core long-term holdings are offset by the gains in these short-term hedges.
Build up cash reserves
Having cash on the side can help you with three things:
- Tide you over short term liquidity needs
- Reduce the need to sell assets at depressed levels
- Capital to buy assets at capitulation levels
We believe that excessive cash is bad, but having cash at around 10% to 20% of your portfolio depending on your comfort level is prudent to make opportunistic investments.
Cash need not be sitting idle in your bank account, it could be put to use in cash management or ultra-safe capital protected investment options with rapid access. Check out our guide below to learn more.
Invest in quality
There's a saying that goes – only when the tide goes out do you discover who's been swimming naked. During euphoric times or bull markets, everyone is making lots of money with high beta stocks or using tools like leverage.
In bear markets, lenders are less willing to lend to preserve capital. Cost of borrowing goes up, and many unprofitable businesses reliant on external financing may go bankrupt, and equity investors may lose their entire capital.
We prefer investing in value over growth stocks in this macroeconomic environment or keep a neutral stance on a global equity allocation that automatically rebalances between growth and value in their market-cap weighted proportions.
Is there light at the end of the tunnel?
The good news is – history books have shown that markets always recover.
With time, they recover to prior highs and continue to make new highs. The bad news is, not every investor gets to enjoy that, especially if you capitulate, sell at the bottom, or have your portfolio wiped.
Time in the market beats timing the market.
Long-term investors should take this opportunity to dollar cost average into the markets at a discount and not time the bottom. Over the next 1-2 years, it's possible that markets trend in a range with huge volatility to both on the upside and downside.
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