The Horizon

Staying the Course During Volatile Times


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. 

The first quarter of the year was characterized by a sustained Federal Reserve tightening campaign, banking sector uncertainty, still-elevated levels of inflation and significant market volatility across the board. We believe it is important to stick to a diversified and long-term investing strategy during these periods of uncertainty, with the ability to make tactical asset allocation decisions as the year progresses. In this report we break down the rationale behind long-term investing, how to interpret the current banking sector predicament, several triggers for a new equity bull cycle to be aware of and the ultimate impacts on an investor’s portfolio.

“Overall, we believe that developing a longer-term investing strategy will allow environments of financial stress and market uncertainty to be interpreted as opportunities rather than obstacles.”
— Marci McGregor, Managing Director and Head of CIO Portfolio Strategy

Market pullbacks can be seen as opportunities for long-term investors to increase their exposure to high-quality investments. In this way, volatility is a normal and vital part of “The Journey of Long-Term Investing.”1 Looking at historical trends, Equity market declines of 10% to 20%, similar to the one experienced in 2022, occur roughly every 2.5 years,2 making them relatively regular occurrences, with the market typically recuperating these losses in about four months. More severe downturns of around 20% to 40% materialize more sporadically, about once every 8.6 years, recovering their selloff in about 14 months, on average.2 There are several actions investors might consider during periods of challenging financial circumstances. First, stay invested in the market. The probability of losing money over a one-year holding period is 26%, whereas the likelihood of losing money is only 6% for a 10-year holding period.3 Moreover, any tactical changes may need to be more micro than macro as the impact of weaker economic activity and still-tight financial conditions may be unique to certain sectors, industries and companies. We suggest looking for total return prospects. Dividends and other forms of yield could become more significant as the Equity market may be more subdued in the near-term compared to prior years of robust returns. Overall, we believe that developing a longer-term investing strategy will allow environments of financial stress and market uncertainty to serve as opportunities rather than obstacles.

In our piece, “A Unique Situation Leads to High Alert and Important Perspectives,”4 we explore the recent impact of instability in the banking sector related to a small number of regional banks. This situation, while notable, occurred for specific reasons that were unique to these banks, such as over-exposure to high growth, concentrated and uninsured deposit bases and speculative investment areas. While we predict sentiment to be on heightened alert throughout this resolution period, these banks can be considered outliers. Furthermore, metrics used to measure financial system credit risk, such as investment-grade credit spreads, high yield credit spreads, the Bloomberg Short-Term Bank Yield Index, the Libor-Overnight Index Swap spread and the General Collateral Repo (Treasurys) are currently oscillating in a normal range and do not appear to show signs of distress. While we expect more market volatility to occur both in the financial sector and the broader Equity market, we believe this situation to be isolated and that the U.S. financial system is generally solid and well-capitalized. From an investing standpoint, investors should consider using a dollar cost averaging approach to rebalance exposure to higher-quality areas, with firm fundamentals, within Equities and Fixed Income. We continue to emphasize the importance of a detailed and disciplined investing approach with a longer-term outlook.

“The next phase of the market cycle may be characterized by a more volatile economy, a potential shift in monetary policy and slower global growth. In light of this grind-it-out market environment, we continue to emphasize the need to maintain a long-term and diverse investing mindset with room to make tactical changes along the way.”
— Marci McGregor, Managing Director and Head of CIO Portfolio Strategy

To help investors in rebalancing their portfolios during this volatile environment, we highlight several factors that could suggest the beginning of a new Equity bull cycle. “An Update on Triggers to Monitor for a New Equity Bull Cycle,5 identifies important characteristics for investors to keep an eye on including a peak in labor market weakness, stabilization of earnings downgrades, a shift of core inflation closer to the Fed's target, a peak in the 2-year Treasury yield, a spike in volatility and a weaker U.S. dollar. The labor market has remained a key source of strength for the U.S. economy in recent months but may be beginning to deteriorate. While the unemployment rate has stayed relatively low, some major technology and finance companies are reducing headcount following pandemic-induced hiring sprees. The end of Q4 2022 earnings season proved disappointing as the S&P 500 showed a year-over-year decline in earnings for the first time since Q3 2020. Additionally, BofA Global Research forecasts a 9% decline in earnings per share (EPS) for 2023. While that is only half of the typical EPS drop in a recession, it could be an indication of further deterioration before stability. Core inflation has slowly come down from a multi-decade high on the heels of 475 basis points in cumulative interest rate hikes by the Federal Reserve. This shift lower in core inflation could create a runway for the start of a new equity bull cycle. Furthermore, we are cautiously optimistic that the 2-year Treasury yield has already peaked, which should assist the stabilization of the Equity landscape, especially for the growth segments of the market. Based on historical trends, Equity market troughs have closely followed when the Chicago Board Options Exchange Volatility Index (VIX) has risen above 40. While the market has experienced some volatility in Q1, the VIX Index has been able to maintain a level of around 20, suggesting we may not have reached this significant turning point yet. Lastly, the U.S. dollar appears to have weakened, coming off a two-decade high in September of last year. Ultimately, these factors are important for investors to monitor as they think about deploying capital over the next several months.

The next phase of the market cycle may be characterized by a more volatile economy, a potential shift in monetary policy and slower global growth. In light of this grind-it-out market environment, we continue to emphasize the need to maintain a long-term and diversified investing mindset with room to make tactical changes along the way.

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1 Chief Investment Office, “The Journey of Long-term Investing,” February 2023.

2 Sources: Chief Investment Office; Yardeni Research; Bloomberg as of January 27, 2023. Analysis of S&P 500 drawdowns and recovery times since 1946, excluding the 2022 market drawdown. Past performance is no guarantee for future results. Performance would differ if a different time period was displayed. Short-term performance shown to illustrate more recent trend.

3BofA Global Research, Chief Investment Office. Data as of December 30, 2022.

4 Chief Investment Office, “A Unique Situation Leads to High Alert and Important Perspectives,” March 2023.

5 Chief Investment Office, “An Update on Triggers to Monitor for a New Equity Bull Cycle,” Capital Market Outlook, January 30, 2023.

Important Disclosures

All data, projections and opinions are as of the date of this report and subject to change.

This material does not take into account a client’s particular investment objectives, financial situations or needs and is not intended as a recommendation, offer or solicitation for the purchase or sale of any security or investment strategy. Merrill offers a broad range of brokerage, investment advisory (including financial planning) and other services. There are important differences between brokerage and investment advisory services, including the type of advice and assistance provided, the fees charged, and the rights and obligations of the parties. It is important to understand the differences, particularly when determining which service or services to select. For more information about these services and their differences, speak with your Merrill financial advisor.

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.”).

BofA Global Research is research produced by BofA Securities, Inc. (“BofAS”) and/or one or more of its affiliates. BofAS is a registered broker-dealer, Member SIPC and 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.