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Imperative Insights for Investors
The Horizon is a quarterly report from our Chief Investment Office, exclusive to Merrill Private Wealth Management, intended to help high net-worth clients pursue their personal goals by addressing timely topics in areas such as macroeconomic trends, long-term investment themes, market dynamics, asset allocation and portfolio strategy as well as wealth structuring, planning and transfer.
“For the foreseeable future, the broader equity market likely will continue trying to come to grips with competing story lines and factors, creating a grind-it-out environment across asset classes. In this environment, it’s important to remember that volatility is considered normal, and pullbacks may create an opportunity for long-term investors to consider adding high-quality investments.”
The first quarter of 2022 was a tumultuous one as markets worked through a number of headwinds, including elevated volatility, a major geopolitical crisis, tightening financial conditions and the hottest inflation reading in 40 years. So far this year, we have written extensively about what this turmoil means for investors, reiterating the importance of staying committed to a disciplined investment approach in the face of uncertainty.
Our market thesis for 2022, as highlighted in The Meerkats and the Buffalo Market1, still includes higher volatility and larger pull-backs than occurred in 2021. We continue to believe that we are in the midst of a “buffalo market”—one that is still in the bull family but tends to roam more and get spooked easily, and is less attractive overall. For the foreseeable future, the broader equity market likely will continue trying to come to grips with competing story lines and factors, creating a grind-it-out environment across asset classes.
In this environment, it’s important to remember that volatility is considered normal, and pullbacks may create an opportunity for long-term investors to consider adding high-quality investments. In The Journey of Long-term Investing2, we indicated that shallow 5% pullbacks happen quite regularly―on average three times a year for the S&P 500 ―and that the market tends to bounce back quickly from these. Declines of 10% to 20% are also not that uncommon and occur about once every 2.5 years, with the markets recovering the selloff in roughly four months. Severe declines of 20% to 40% are usually associated with recessions and occur about once every 8.6 years, but even with those markets recover fairly quickly from the perspective of a long-term investor―14 months on average.3
“In our view, the global economy and the attendant financial markets are in a new and unique phase, with very different characteristics from the 2016–19 and the 2020–21 time frames. The current phase of the market cycle is characterized by higher inflation, lower central bank liquidity, and lower investment returns.”
Market volatility is likely to remain elevated in the coming weeks, as the crisis in Ukraine remains a fluid situation. But investors should keep in mind that historical geopolitical shocks have been short-lived, with markets recovering and then some in the following months. In An Examination of Past Crises as a Guide to the Present4, we found that following major geopolitical events the S&P 500 has returned 8.8% in the subsequent 12 months, 6.8% in the subsequent 6 months, and 2.6% in the subsequent one month, on average.5 For investors, this underscores the importance of diversification and disciplined portfolio positioning.
It’s also imperative to understand that the macroeconomic backdrop is continuously shifting. In our view, the global economy and the attendant financial markets are in a new and unique phase, with very different characteristics from the 2016–19 and the 2020–21 time frames. In The Changing Forces Driving Asset Allocation6, we examine how the fundamental elements of asset allocation have evolved (Exhibit 1).
Exhibit 1: Key Forces Driving Asset Allocation by Era
|The Slow Expansion Era
|The Pandemic Disruption Era
|The Great New Dawn Era
(2022 – beyond)
|Real Growth||Remained anemic near 2%||Historically high near 4%-6%||Should glide lower to trend levels|
|Inflation||Generally below Federal Reserve (Fed) target||Rose to over 7% for CPI||Persistently high|
|Money supply||Normal 3%-7% expansion||Exploded higher to 13%-25%||Likely slows substantially|
|Fed funds rate||Gradual increase to 2.50%||At zero bound||Multiple hikes expected|
|Fed balance sheet||Increased to about $4.5T||Increased to about $9T||Quantitative tightening|
|Fiscal stimulus||Tax cuts to improve U.S. corporate competitiveness||Stimulus to support households, state & local governments, small businesses||Fiscal drag given less likelihood of new spending|
|Company fundamentals||U.S earnings outpaced international; shareholder returns favored over capex; companies maintained leverage over labor||Profit margins rose; large companies fared better from pandemic disruptions; technology began to reshape business models; capex rose||Cyclical earnings revival; dispersion based on pricing power and economic moat; accelerating creative disruption; labor gains leverage|
Source: Chief Investment Office, Bloomberg. Data as of March 9, 2022.
The current phase of the market cycle is characterized by higher inflation, lower central bank liquidity, and lower investment returns. As outlined in The Journey of Long-term Investing7, we suggest that investors consider the following:
All data, projections and opinions are as of the date of this report and subject to change.
Bank of America, Merrill, their affiliates, and advisors do not provide legal, tax, or accounting advice. Clients should consult their legal and/or tax advisors before making any financial decisions.
This information should not be construed as investment advice and is subject to change. It is provided for informational purposes only and is not intended to be either a specific offer by Bank of America, Merrill or any affiliate to sell or provide, or a specific invitation for a consumer to apply for, any particular retail financial product or service that may be available.
The Chief Investment Office (CIO) provides thought leadership on wealth management, investment strategy and global markets; portfolio management solutions; due diligence; and solutions oversight and data analytics. CIO viewpoints are developed for Bank of America Private Bank, a division of Bank of America, N.A., (“Bank of America”) and Merrill Lynch, Pierce, Fenner & Smith Incorporated (“MLPF&S” or “Merrill”), a registered broker-dealer, registered investment adviser and a wholly owned subsidiary of Bank of America Corporation (“BofA Corp.”).
All recommendations must be considered in the context of an individual investor’s goals, time horizon, liquidity needs and risk tolerance. Not all recommendations will be in the best interest of all investors.
Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss in declining markets.
Investments have varying degrees of risk. Some of the risks involved with equity securities include the possibility that the value of the stocks may fluctuate in response to events specific to the companies or markets, as well as economic, political or social events in the U.S. or abroad. Bonds are subject to interest rate, inflation and credit risks. Treasury bills are less volatile than longer-term fixed income securities and are guaranteed as to timely payment of principal and interest by the U.S. government. Investments in foreign securities (including ADRs) involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are magnified for investments made in emerging markets. Investments in certain industry or sector may pose additional risk due to lack of diversification and sector concentration. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments, and yields and share price fluctuations due to changes in interest rates.
Alternative investments are intended for qualified investors only. Some or all alternative investment programs may not be in the best interest of certain investors. No assurance can be given that any alternative investment’s investment objectives will be achieved.
Alternative Investments such as derivatives, hedge funds, private equity funds, and funds of funds can result in higher return potential but also higher loss potential.