The Risk of De-Risking
Economic uncertainty is causing investors to de-risk portfolios at a time when the long-term outlook for stocks has drastically improved.
Contributed by Doug Walters , Max Berkovich , David Lemire , Eh Ka Paw
Investors face a paradox, and it goes like this… taking risk out of your portfolio can increase the risk that your financial plan fails. Higher yields and scary economic headlines are tempting many to shift their portfolios out of riskier assets like stocks into the safety of cash. But now is not the time for long-term investors to de-risk.
The “right” level of risk taken in any investment portfolio is a combination of the investor’s ability, willingness, and need to take risk. Sometimes those factors are in conflict. Negative financial headlines may make someone less willing to take risk, but it does not change their ability or need to take risk. It is important to be able to sleep at night with your investment decisions today, but not to the detriment of sleepless nights later in life. Generally, higher investment risk is rewarded with higher portfolio returns over time. Taking too little risk today could result in falling short of your future goals and dreams.
So, what about today? While it may seem a tenuous market environment, the prospects for future stock and bond returns are much higher today than at the beginning of 2022. Why? Market declines in 2022 have reset the bar for higher potential future returns. JP Morgan publishes an impressive book of expected future returns each year, looking out 10-15 years. Their expected annual return for US large-cap stocks increased from 4.1% to 7.9%. That is an enormous jump. In their words, “Lower valuations and higher yields mean that asset markets today may offer the best long-term returns in more than a decade.”
So markets are going to rise in 2023? Not necessarily. No one without a crystal ball can predict short-term market returns. But for investors with a long-time horizon, today would appear to be an attractive entry point and not a time to de-risk portfolios. In the words of Warren Buffett, be “fearful when others are greedy, and greedy when others are fearful.”
Headline of the Week
The Second Front
In military conflicts, the generals are loathed to fight on two fronts. General Powell and the commanding officers of the Federal Reserve faced a decision this week with implications for their two-front war. Raise rates to concentrate efforts on the inflation front or pause rate hikes to focus on the financial stability front. Switching from military to sewing, getting this decision right is a tough needle to thread.
The Fed seems to be deploying resources to both fronts with the most anticipated 25 bps hike in western civilization. Given the previous talk of 50 bps, a 25 bps hike seems more palatable and signals to markets that the Fed is staying the course on inflation. The Fed also is attempting to keep interest rate decisions focused on inflation, and the Fed’s other tools (Discount Window and the new Bank Term Funding Program) focused on stability issues.
Contrary to military theory, the Fed may prefer to battle on two fronts. Should these issues merge, or rather, should the Fed be forced to deploy interest rate policy on the stability front, that could signal a more dire economic outlook.
The Week Ahead
Another weekend of watching bank news is in store with Deutsche Bank under the microscope. It should be a somewhat dull week, with only Gross Domestic Product and the Personal Consumer Expenditures inflation index at the end of the week to deliberate.
Friday’s Personal Consumption Expenditures (PCE) Price Index is said to be the Federal Reserve’s favorite inflation gauge.
- The January core-PCE (excluding food and energy) report unexpectedly increased. Hopes are that the February numbers will tick down some.
- Inflation has proven to be sticky, despite the frantic pace of rate hikes.
- A definitive decline in inflation would help quell the inflation hawks and allow the central bank to focus on supporting the banking system.
- Luckily, the central bank does not have a rate decision in April, so we should get more inflation figures before they have to make a move.
- Inflation in the service sector will be the big focus, along with the personal income and spending numbers that come with this report.
Thursday’s U.S. Gross Domestic Product (GDP) is the last read for the 4th quarter of 2022.
- Any change in the previously reported 2.7% expansion will make news.
- However, it was a declaration from the third quarter’s 3.2% growth rate.
- Consumer consumption was weak at the end of last year, but economists brushed it off with some reversing trends in the early part of 2023.
- A revision higher would be a welcome way to shut the book on 2022.
NCAA March Madness continues this weekend, and Major League Baseball’s Opening Day is on Thursday.
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