The Horizon

Investing through the Reset Period

 

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.

 

“Investors should keep in mind that reset periods are not uncommon for financial markets—declines of 10% to 20% occur about once every 2.5 years, with the markets recovering the selloff in roughly four months.”

— Neel Mukherjee, Managing Director and Head of CIO Portfolio Strategy

Heading into mid-year, the near-term outlook for the global economy is clouded with uncertainty surrounding the crisis in Ukraine, ongoing coronavirus concerns, multi-decade high inflation, and a global slowdown in economic growth and profits. The confluence of these events have roiled markets in the first half of the year and are likely to continue to drive volatility until there is more clarity on the immediate future. In the second half of 2022, more economic, corporate and market data will be released on these fronts and we believe the final workout process stage will be upon us.  We recount what investors should consider as the workout process continues.

In our view, the first half of 2022 marked the beginning of the Five Stages of The Reset Period.1 Q1 saw initial moves off market highs, with rolling bear markets emerging in certain low-quality areas. Volatility continued into Q2 as financial conditions started to tighten, defensive postures were built, and Equity valuations significantly corrected. In the stages of the reset period, central banks raise interest rates and/or contract their balance sheets, and economic data may weaken before beginning to stabilize. Eventually a new market cycle is firmly established which converges back into the long-term secular bull market trend, but we think that markets will continue searching for signs of stability before bottoming out and finding a new base. Investors may want to consider making adjustments to their investment strategy as this period of uncertainty matures.

In A Three-Pronged Framework to Manage through Volatility,2 we highlight an approach that keeps one invested and positions tactically for near-term volatility while picking up attractive secular growth investments. We believe investors should maintain the balance of global diversification, interest rate and credit risk, and Value and Growth exposure while implementing appropriate rebalancing. Investors should also consider tactical exposure to areas like dividend-growth, high-quality, and Equity Hedge that can help manage through elevated inflation and near-term volatility. Long-term investors may want to take advantage of pockets of the market that have fallen out of favor despite having attractive long term fundamentals. Recently we have seen better valuations for secular growth areas like semiconductors, homebuilders, biotechnology, clean energy, robotics and cybersecurity. Some of these areas are susceptible to further downside, but the strategy should be to keep a long-term perspective, acknowledge that the bottom is impossible to time and start to build positions along the way as episodic volatility hits.

“Long-term investors may want to take advantage of pockets of the market that have fallen out of favor despite having attractive long-term fundamentals.”

— Emily Avioli, Assistant Vice President and Investment Strategist

Amid heightened uncertainty and changing expectations for future, investors may also want to consider Enhancing the Traditional Investment Strategy.3 Investors have long relied on a 60/40 portfolio construct, or a mix comprising a 60% allocation to Equities and a 40% allocation to Fixed Income. Looking back at its long-term historical performance since 1926, the strategy has worked well, averaging 8.9% in annual total returns. It only saw negative 12-month returns 19% of the time with an average negative return of -8.5%, while positive annual returns occurred 81% of the time, averaging 13.8%.4 But the construct has recently come under pressure as the correlation between stocks and bonds flipped positive, and several shifting elements of the investment environment could lead to further weakness in both stock and bond markets. Amid this new backdrop, appropriate allocations to Equities and Fixed Income may be complemented by exposure to non-traditional investments like Alternative Investments for qualified investors, including Real Assets comprised of Commodities and Real Estate. These asset classes could help mitigate risk and potentially enhance returns in a regime of high-inflation, elevated uncertainty, volatility and slow growth.

In Staying the Course: A Disciplined Financial Strategy Roadmap,5 we discuss a number of important elements to review when assessing portfolios and potential adjustments to consider during times of heightened uncertainty. Our view remains that the key principles of a long-term financial strategy include staying disciplined with a goals based plan, maintaining a diversified portfolio and adequate liquidity, and considering a defined investment strategy. This may involve employing dollar cost averaging techniques that can smooth out the entry price of a particular asset and help investors avoid investing too much when the market is high and too little when the market is low. Keep in mind that dollar cost averaging cannot guarantee a profit or prevent a loss. Since such an investment plan involves continual investment in securities regardless of fluctuating price levels, you should consider your willingness to continue purchasing during periods of high or low price levels. Although geopolitical events and market volatility are beyond our control, these actions can help investors weather periods of turbulence.

Conclusion

Investors should keep in mind that reset periods are not uncommon for financial markets—declines of 10% to 20% occur about once every 2.5 years, with the markets recovering the selloff in roughly four months. The various approaches outlined above may help investors mitigate near-term risk and potentially enhance returns during times of heighted volatility. Throughout the workout process, investors should continue to ensure that their core investment strategy aligns with their long term financial plans and emphasize diversification across and within asset classes as an evergreen principal of long-term investing.

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Chief Investment Office, “Five Stages of the Reset Period.” May 2022.

Chief Investment Office, “A Three-Pronged Framework to Manage through Volatility.” Capital Market Outlook, May 9, 2022.

Chief Investment Office, “Enhancing the Traditional Investment Strategy.” Capital Market Outlook, May 31, 2022.

Based on monthly returns from 1926 to April 2022 for a 60/40 portfolio with the following proxy indexes used: Stocks—S&P 500 Total Return Index and Bonds—IA SBBI U.S. Intermediate Government Total Return from January 1926 to December 1975 and Bloomberg Barclays U.S. Aggregate Bond Total Return Index from January 1976 to April 2022. Sources: Morningstar; Chief Investment Office. Data as of April 29, 2022. The asset allocations between stocks and bonds used in this analysis are for illustrative purposes only.

5 Chief Investment Office, “Staying the Course: A Disciplined Financial Strategy Roadmap.” April 2022.

Important Disclosures

Opinions are as of the date of this article 07/20/2022 and are subject to change.

Investing involves risk, including the possible loss of principal. Past performance is no guarantee of future results.

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.

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.

Bonds are subject to interest rate, inflation and credit risks. 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. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risk related to renting properties, such as rental defaults. 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.

Nonfinancial assets, such as closely-held businesses, real estate, fine art, oil, gas and mineral properties, and timber, farm and ranch land, are complex in nature and involve risks including total loss of value. Special risk considerations include natural events (for example, earthquakes or fires), complex tax considerations, and lack of liquidity. Nonfinancial assets are not in the best interest of all investors. Always consult with your independent attorney, tax advisor, investment manager, and insurance agent for final recommendations and before changing or implementing any financial, tax, or estate planning strategy.

Keep in mind that dollar cost averaging cannot guarantee a profit or prevent a loss. Since such an investment plan involves continual investment in securities regardless of fluctuating price levels, you should consider your willingness to continue purchasing during periods of high or low price levels.

Dividend payments are not guaranteed, and are paid only when declared by an issuer’s board of directors. The amount of a dividend payment, if any, can vary over time.