Martin Pelletier: Buy the dip, buy and hold, and the 60/40 portfolio can be reconfigured to prevent further harm to your portfolio
Can you imagine buying Zoom Video Communications Inc. when it was worth more than Exxon Mobil Corp. back in October 2020, or even buying it as it sold down? Photo by Justin Sullivan/Getty Images One of the reasons this market correction feels so different than others is that the strategies that worked so well in the recent past are suddenly no longer helping and could be making things worse, creating quite a challenge for many investment advisers relying on three mantras: buy the dip, buy and hold, and the 60/40 portfolio.
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For the most part, these strategies work very well, at least until there is a fundamental step change in the market such as we’re witnessing today, with inflation not only taking root, but getting worse because central bankers are overly cautious about raising rates and governments do not want to budge on their massive fiscal deficit programs.
Instead of doing what they’re designed to do, these strategies could actually hinder performance unless executed correctly via tactical asset allocation.
Here’s how they can be reconfigured to prevent further harm to your portfolio and help repair and rebuild it for a recovery.
Know where to buy the dips and sell the rips Averaging into the market can be a powerful tool, especially for younger investors. But the consequences of concentrated bets on any sector or market at the wrong time can be catastrophic if you’re not careful.
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Article content For example, can you imagine buying Zoom Video Communications Inc. when it was worth more than Exxon Mobil Corp. back in October 2020, or even buying it as it sold down? Zoom is down 80 per cent since then, sending its value back to less than a 10th of Exxon’s current market value.
With hindsight, one would think this would have been an easy trade to avoid, but keep in mind that it was commonly thought there was a structural shift away from traditional assets towards new-world technological ones. This was reinforced by the supposedly bulletproof, tech-heavy S&P 500 over the past decade.
Why not buy the dips, the argument went, since the market would outperform once we returned to the days of deflation and the so-called United States Federal Reserve put, which is very supportive of long-duration segments of the market such as tech?
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Article content Few asked what would happen if interest rates had to drive higher due to persistent inflation, nor did they ask what would be the impact on companies with low levels of cash flow that dominate certain markets like the U.S.
But Greg Jensen, co-chief investment officer and head of the investment engine at Bridgewater Associates LLC, did. On a recent podcast, he pointed out that “40 per cent of the U.S. equity market can only survive with new buyers entering the market because they’re not cash flow generating. That’s near historic highs.”
Be tactical with your buy and hold Buying and holding is a strategy that has withstood the test of time: the longer one stays invested, the greater the probability of a loss falls to near zero. But having an overweight or concentrated position in any one sector or market can result in serious underperformance when given enough time due to the power of mean reversion.
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Article content This is the primary problem with benchmarking to a certain index, since one will naturally gravitate towards whichever segment of the global market is outperforming.
Instead, take a balanced approach by owning all segments, but with a tilt towards certain areas or regions or sectors based on the underlying fundamentals. For example, in today’s environment, we’re overweight inflationary segments such as energy, materials, industrials and financials while still owning a slice of the broader S&P 500, albeit being underweight.
Moving beyond the traditional 60/40 The infamous 60/40 stock/bond portfolio has been bulletproof until this year. This is because there was plenty of room for interest rates to fall during market corrections, which in turn would boost the value of bonds and offset a portion of the equity losses.
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Article content This allocation has worked for the better part of the past 35 years as interest rates trended lower and lower to the point of going negative in some areas.
Here’s a better strategy for investors than trying to catch falling knives Here’s how to turn the gut-wrenching test of a market correction to your advantage The markets are throwing a tantrum, but this time central banks may not bail them out Two common mistakes that can cost investors in these volatile times That said, inflation is forcing central bankers to raise interest rates, but both bond and equity market participants continue to factor in severely moderated inflation expectations along with lower interest-rate hikes. Therefore, there are more downside risks ahead, especially in long-duration bonds and equities.
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There are other risk-management tools available that investors can consider as a replacement for traditional fixed-rate government and corporate bonds, including floating-rate bonds, inflation-protected notes, alternatives, commodities and even structured notes linked to equity indexes but with embedded downside protection.
Now is a great time to introduce a formal tactical asset allocation strategy into your portfolio, one that can really help navigate what appears to be a very top-down, macro-driven market that is trying to figure out where to go next.
If your portfolio is getting hammered in this volatile market, it is not the time to simply sit tight and expect it will all work out or, worse, average down on a losing strategy. Instead, look for some specific help from your adviser to rebalance and repair the damage while repositioning for the recovery.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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