Our Approach to Difficult Markets

Contributed by Doug Walters , Max Berkovich , David Lemire

It is no secret that 2022 has not been a fun year for investors with both stocks and bonds down (not to mention all those other shiny objects that hopefully were avoided… crypto, meme stocks, SPACS, NFT art, to name some of the biggest offenders. It is common in times like this for investors to ask their advisors, “what are you doing about it?” We spend some time today answering that question.

To set the stage, we are evidence-based investors. We do not prescribe to the notion that we have the ability to predict the future. As such, asset allocation is set assuming that the future is unknown because, by definition, it is! But we are not passive investors. Far from it. We see it as our job to actively stack the odds in favor of our client’s portfolios with the goal of outpacing a passive approach.

So with speculation not in our toolkit, what have we been doing this year?

• First, we place proven, persistent factors at the core of our client portfolios. We hold stocks that demonstrate an above-average level of Quality, Value, Momentum, and Small Size. Stocks with these characteristics have historically outperformed a passive approach.
• From an allocation perspective, we started the year equal weight equities. It seems like a long time ago, but back in January equities were at a lofty valuation that we would classify as “the high end of normal.” We know that over time, equities tend to go up. Therefore, to go underweight is betting against the odds, and market valuation six months ago was not high enough to justify such a move.
• Accordingly, the first bout of equity declines this year was simply working off the valuation froth and required no major equity allocation changes.
• Yet, we were very active in this market weakness. We practice what we call opportunistic rebalancing. Rather than rebalancing once a quarter, we look for opportunities at the security level weekly. The evidence shows that giving securities significant ability to drift yet looking often for when they have drifted too far can systematically enhance returns. Essentially we are selling high and buying low at the security level on a weekly basis. Why? To shift the odds in our client’s favor.
• As the equity market continued to decline additional opportunities have emerged. With inflation high, the opportunity in TIPS diminished (i.e., that trade had already played out). In addition, specific equity market segments began to display valuation significantly below the normal range, namely Small-Cap and International. We used these dynamics to close our overweight to TIPS and add exposure to attractive segments within equities. None of these moves require us to know what will happen in the next six months. Instead, they are based on the fact that these assets are trading outside their normal range.

What will be our next move? That depends on where the market moves from here. Should stocks continue to decline, that would undoubtedly create pockets of buying opportunities. We see it as our job not to predict those buying opportunities but to take advantage of them when they occur.

Market declines can be emotional, but implementing an evidence-based approach that aims to systematically put the odds in your favor can provide much-needed peace of mind.