With the trend that we are carrying throughout this year 2022 with the markets dyed red, surely your thought has been to stay away from investments at all costs. But let's remember that during bear markets is where the best opportunities arise. So let's go over how to position our stock investment portfolio when everything is falling.
Why is everything falling?​
The markets have been dominated this year by two factors: the high inflation and the rises of Interest rate. These two factors are the reason why the economy is experiencing these declines, and why investors are selling almost all of their assets. We already know that inflation directly affects investment in stocks and bonds. Therefore, a slowdown in growth is a bad sign for stocks and commodities. Increases in interest rates, on the other hand, affect almost all assets. In this environment, everything goes down except cash.
Stocks, bonds, gold and other commodities are selling off. Source: Tradingview.
The good news is that in an environment where cash outperforms all assets it is highly unusual and unlikely to last for long. At some point, some assets will win. In the worst case, rising interest rates will end up doing what they usually do: pushing the economy into a recession. As demand plummets, inflation will likely drop enough for the Federal Reserve (Fed) to cut interest rates again to support the economy and, above all, the labor market. In that environment, stocks and commodities will fall, but we can expect assets like Treasuries and gold to perform well, just as they did in 2008.
At some point, some assets will recover (like gold and Treasuries in 2008). Source: Tradingview.
In the best-case scenario, the Fed will manage to raise rates enough to curb inflation, but not so much that the economy goes into recession. In this case, stocks, commodities, and even bonds are likely to skyrocket.
What assets should we buy now?
This is the million-dollar question if we have a short-term investment time horizon and are looking for good returns. If that is the case, we have to choose the right asset, because in the short term, some assets will go up, others will go down and very few will generate good returns. And with all the macroeconomic uncertainty, choosing the right ones has never been more difficult. If, on the other hand, you have a long-term investment time horizon and reasonable profitability expectations, then it would be best to diversify your portfolios as we taught you in previous articles. Over the long term, asset returns have to outperform cash. And in the medium term, a balanced portfolio will prevent you from being too exposed to a particular macroeconomic environment. So we won't have to worry too much about predicting what the economy will do in the future.
We have a type of investment that performs well in each environment.
In an environment like the current one, you can see that as asset prices fall, future returns increase. For example, stocks and bonds were overvalued a few months ago, but now they are trading at a more attractive valuation. Those who buy at these discount levels are likely generating much higher returns than those who bought when prices were hitting highs. Therefore, those who buy at even lower levels are likely to achieve higher returns in the future.
How can we position our investment portfolio in stocks?
At the moment, we do not know if prices have reached a bottom. And considering how aggressively the Federal Reserve has to raise rates to curb inflation, selling pressure is likely to become more prevalent in the near term. We must consider each decline in asset prices as a possible opportunity to build a solid portfolio at discounted levels. If our time horizon is longer, and we do not want to be too active in managing our stock investment portfolio, a good strategy would be to spread out our initial investment and buy regularly or when prices reach an optimal level.
For example, let's assume that we have 6.000 euros to make an investment in shares. We could divide that money into three parts, investing the first 2.000 euros today, and investing the other 2.000 euros every quarter or semester or if the shares fall between 15-30%. If the shares fall before the set investment times, we will have built our position at a lower price. On the other hand, if stocks recover while we continue to hold onto our cash, we will only have lost the first few months. Now, if we apply that same strategy to our mix of stocks, Treasuries, gold, and other commodities, we are likely to build a solid portfolio at attractive prices.