As investors catch their breath after a volatile start to the year, a report from Richardson Wealth offers a warning: “If the reversals in January were tough to stomach, it may be time to revisit your risk profile.”
The firm’s investor report for February, released on Tuesday, noted that even well-balanced portfolios suffered last month with bonds and equities down, and international markets highly correlated.
“After a formidable run since March 2020, with the S&P 500 nearly doubling and the TSX up over 80%, markets finally answered the volatility door in January that had been knocking repeatedly,” the report said. “News, headlines and data that could have derailed equities throughout 2021 were finally heard, leading to massive selloffs in many markets and sectors.”
Did the first month of 2022 mark the death of the “buy the dip” ethos? The report suggested certain secular shifts could be underway.
A Natixis Investment Managers survey of investment professionals late last year also pointed to shifts in asset allocation. Eight in 10 respondents in North America said investors have taken on too much risk in pursuit of yield during the prolonged low-rate environment and now call for portfolio repositioning.
There were “pockets of relief” from last month’s selloff, the Richardson report said. While the S&P 500 finished down more than 5% in January, the S&P/TSX’s large concentration in energy and financials helped it to almost eke out a positive month.
The report’s authors said this points to the decade-long trend of growth outperforming value finally running out of steam.
Pandemic consumer trends focused on social isolation and goods are likely to crest this year, it said, with spending shifting back to services. At the same time, economic growth and earnings growth should remain above average, while high inflation will continue to hobble growth stocks.
While the authors “don’t expect growth to go quietly into the night” after a dominant decade, a longer-term rotation to value would create new winners and losers. Canada and Europe would be favoured, the report said, while the S&P 500 has become more concentrated on the growth side.
“Within the U.S., tilting more towards dividend–paying companies reduces the growth exposure,” the report said. “Even using an equal–weighted ETF has helped to reduce the impact of the growth names that have grown to be giants over the past decade of outperformance.”
The report also noted that the U.S. led the economic recovery from the pandemic-induced recession, closing its output gap last year, while some slack remains in Canada and Europe. This so-called catch-up trade is another case for paring back overweight U.S. positions.
The managers surveyed by Natixis also saw a rotation coming. Almost seven in 10 expect better returns from value over growth, and 58% favour small-cap companies over large cap. However, almost three in four expected big tech to “grow unabated.”
The Richardson report also addressed fixed-income investments at a time when rate hikes and an end to quantitative easing make bonds a “scary proposition.”
However, the authors said they’re starting to see “decent value” in bond markets again. Investment grade bonds over five years and long provincial bonds have yields around 3%, and some long corporates are even higher.
“This is providing decent real returns, given long–term inflation expectations still below 2%,” the authors wrote. “Therefore, it is time for investors to consider looking at fixed income again, especially longer duration bonds. The returns from the asset class will likely remain shy of what equity markets may return, but they should exceed the returns on cash.”
The Natixis survey found investors remained committed to the role of fixed income in portfolios. However, 88% emphasized the importance of countering duration risk as rates begin to normalize, and almost three in four recommended alternative strategies to generate yield with rates still historically low.