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Volume 11, Edition 7 | February 21 - February 25, 2022

Investing Rationally in Emotional Times

Doug Walters, CFA
In a difficult week, like we just experienced, investors need to balance their emotions for the geopolitical tragedy in Eastern Europe with the rational decisions they need to make for long-term portfolio success.

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.

A Closer Look: Investment Volatility

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.

Headlines This Week

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.

The Week Ahead

All Eyes on Kyiv

The invasion of Ukraine will be the backdrop for market direction next week.

  • As of Friday, Russian President Putin was amenable to high-level talks with Ukraine.
  • Chief Economist for European Central Bank (ECB) Philip Lane estimates that the invasion of Ukraine will shave economic output of the European Union by 0.2% to 0.3% percent. With 1% contraction as his worst-case scenario.

Over a Barrel

Organization of the Petroleum Exporting Countries (OPEC) meets on Wednesday with oil futures over $90 a barrel.

  • The Alliance of major oil producers (which includes Russia) is not expected to accelerate its unwinding of supply cuts from 2020 despite the high price of oil.
  • The US’s best hope for relief at the pump rests on convincing Saudi Arabia to pump more oil.
  • Another wild card may be Iran. If a nuclear deal can be reached that would unleash roughly 1 million barrels of crude per day.
  • For the record, roughly 5 billion barrels a day come from Russia.

Capital Concern

Federal Reserve Chairman Powell will be testifying both in the US Senate and Congress this week.

  • With rate hikes slated to begin next FOMC meeting, Politicians will be prying into the Chairman’s mind for clues on where his thinking is.
  • With geopolitics taking center stage this week, trades seemed to take bets of a ½ of 1% hike off the table for March.

Good News is Bad News!

February Non-Farm Payroll report on Friday is predicted to show a gain of 400,000 jobs and the unemployment rate dropping back to 3.9%.

  • Hotter than expected numbers will be bad news for markets as rate hikes will be more likely or more of them.

Rate Watch

The Reserve Bank of Australia and Bank of Canada have rate decisions during the week.

  • The Bank of Canada is expected to hike by ¼ of 1%, as a soft jobs report and trucker protests have taken a ½ of 1% hike off the table.
  • The Australian central bank is expected to raise rates for the first time in over a decade, but that is not supposed to happen until the 3rd quarter.

Earnings still coming

For those still paying attention to earnings reports, there are a few noteworthy ones on the Calendar.

  • DollarTree, Inc. (DLTR), Costco Wholesale Corp. (COST), and Target (TGT) will give a read on retail.
  • Salesforce (CRM), Broadcom Inc. (AVGO), Zoom Video Communications, Inc. (ZM), and Snowflake Inc. (SNOW), the cloud-based data warehousing company, will give something for technology investors to focus on.
  • The weekend release of Warren Buffet’s Berkshire Hathaway (BRKa, BRKb) earnings will certainly catch some attention as well.

About Strategic

Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $2 billion.

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