Investing Rationally in Emotional Times
Contributed by Doug Walters, Max Berkovich, David Lemire
As an investment commentator, writing about the economic facts important to investors while acknowledging the human backdrop is often a tricky balancing act. The pandemic is a great example. On the one hand, we enthusiastically acknowledge the tremendous stock performance of the past two years. On the other, we are conscious that it comes in the wake of great human tragedy. As Russia invades Ukraine, once again, we face this challenge.
Humans are creatures of emotion. It is part of what makes us unique on this planet. Our emotional side needs to acknowledge the suffering and hardship that millions face this week in Eastern Europe. It is truly heartbreaking. But emotions can be a detriment to investors. Investors need not shed all emotion but rather simply ensure emotions are compartmentalized and do not influence otherwise rational investment decisions.
So how should investors approach this latest geopolitical crisis? We recommend an evidence-based approach that looks something like this:
- Don’t panic. Set emotion aside and focus on logic. You cannot predict the future, so do not try. Instead, prepare for it.
- Take comfort in the knowledge that you are investing for the long-term. You can handle market ups and downs as long as your portfolio reflects your long-term willingness and ability to take on risk. Don’t even think about market timing.
- Remember that you have a well-diversified portfolio that is built for market shocks. Diversification does not make you immune to market downturns, but it increases your risk-adjusted returns (the one free lunch in investing).
- Rebalance opportunistically to take full advantage of market volatility. That requires regular monitoring of your portfolio for securities that have significantly under- or outperformed. Using this process, you systematically sell high and buy low – precisely what a rational investor should do.
At Strategic, we follow this evidence-based approach. Our opportunistic rebalancing process constantly looks to capitalize on market dislocations. This year momentum stocks have been underperforming while gold has been outperforming. If those moves are too extreme in any portfolio, we will systematically sell gold and buy cheaper momentum.
Whether it is a pandemic or war, it is natural to feel fear and uncertainty. But those feeling need not translate to your investments. Market volatility is a potential source of long-term outperformance for the disciplined investor.
What is at the heart of investment volatility, not just this week, but this year? In large part, it comes down to inflation and how the Fed plans to deal with it. High consumer demand (driven by huge pandemic stimulus) combined with supply chain disruptions have forced prices up. The Fed’s plan to raise rates and take other actions to combat this inflation (and potentially slow growth) has investors on edge. The developments in Europe have the potential to exasperate this challenge. Inflation could get worse due to energy disruptions (Russia is a big exporter) and growth could slow, particularly with our trading partners in Europe. This has stagflation fears. Stagflation (low growth, low employment, and high inflation), is a much bigger problem than our current high growth, high inflation challenge. We are a long way from stagflation, but the fear is there and it has markets on edge.
All financial news took a back seat to the Russian invasion of Ukraine this week. Even the release of the latest GDP and inflation figures went largely unnoticed.
Crossing the Line
Russian troops entered Ukraine putting to rest any question of will they or won’t they.
- Investors now have another element of uncertainty to add to their calculus.
- At one point on Thursday, US stocks were down close to 5% on the week. However, they have rallied since then and ended the week in positive territory.
- It is important to remember that stock prices are a reflection of future profit expectations of companies and not a measure of the human tragedy of this week’s events.
An Economic Sideshow
Two big economic numbers were released this week, but they were a sideshow to the geopolitical events.
- GDP for the fourth quarter of 2021 was revised up to 7.0% – a big number by any measure.
- Core PCE inflation (historically, the Fed’s preferred measure) came in at 5.2%, slightly above the prior month. Inflation is high, but the appears to be stabilizing.
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on total client assets of over $2 billion.
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