This article is part of the latest Trends and Opportunities report, which seeks to provide therapy for recent market shocks by offering long-term perspective and potential solutions.

Portfolio solutions for this year’s market turmoil

In our last installment of Trends and Opportunities early this year, we focused on U.S. mid caps as an equity portfolio’s “new center of gravity,” examined the merits of being broad in ex-U.S. equities to avoid the growth/value dance, and explained how multisector bond strategies shine when examined through the lens of “empirical” duration.

Since that publication, investors have grappled with severe market shocks from slowing growth, inflation and interest rate volatility. In this edition, we aim to offer some therapy for those shocks by providing a long-term perspective on the markets and economy and presenting quality equities and mortgage-back securities (MBS) as potential solutions to help investors build a resilient portfolio. We also continue the discussion on many of the strategies we covered earlier this year.

Putting volatility in historical context

After living through this year’s volatility, “shock” is probably an understatement. On the bright side, while the history of the S&P 500^® Index tells us there is likely more pain to come, it also tells us that patient investors have historically experienced more upside than downside over the long term. Since 1939, every time the S&P has crossed the 20% loss threshold into bear market territory, additional downside usually occurs. However, inclusive of that drawdown, the next 12 months have resulted, on average, in a positive gain of 15% and a full recovery has always occurred within four years.

In our view, we have now reached the point where investors should view the current landscape as a blank slate and seek to take advantage of new opportunities. No one can call the bottom, but anyone can call a dip: For medium- and long-term investors, the question shouldn’t be if they should take advantage, but how.

Average S&P 500 performance after 20% drawdown 1939 – 2021

Throughout the year, we, like our clients, were weathering the endless assault of distressing headlines. Our response was to publish our Signal and Noise series in an attempt to filter the noise down to a few meaningful investment signals for patient investors:

• Inverting yield curve
  • Noise: Yield curve inversions have reliably predicted recessions
  • Signal: On average, an inversion and recession have not led to negative. returns; the time from inversion to recession has historically been 18 months, with the S&P 500 remaining positive from the inversion to (and through) the recession.
• Recession risk
  • Noise: The endless debate over whether we are entering a recession and fear that the Federal Reserve is breaking the economy with its tightening cycle.
  • Signal: The S&P 500 has weathered past tightening cycles remarkably well, with positive returns seen during and one year after the cycles began, on average.
• High stock-bond correlations
  • Noise: The supposed “death of the 60/40” stock/bond portfolio.
  • Signal: Past market selloffs demonstrate that the bond market has consistently been able to provide a ballast during times of crisis.

The slowing growth, inflation, and interest rate volatility we are currently experiencing are generating market shocks of unusual prominence and magnitude. These shocks will likely drive ongoing volatility to which investors, unfortunately, will need to grow accustomed.

To help investors overcome that trifecta of market shocks, the Portfolio Construction and Strategy Team is focused on providing “shock therapy” in the form of portfolio solutions tailored to this new investing paradigm, while at the same time addressing the ubiquitous asset allocation gaps and concentrations we see in investor portfolios every day through our consultations with financial professionals.

PORTFOLIO CONSTRUCTION AND STRATEGY

TRENDS AND OPPORTUNITIES

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