Portfolio Management Actions in a Changing Market

January 13, 2023 –  The fourth quarter of 2022 resulted in a positive finish to an otherwise difficult year. The stock market reached its high point in the first few days of January 2022. Inflation and rising interest rates dominated both the stock and bond markets for the balance of the year, causing double-digit losses in market indexes. Always, and especially in times of market decline, it is necessary to assess what is working well and what needs changed. What can be improved? What opportunities are there to take advantage of lower prices?  While long-term investment strategy should remain consistent throughout a market cycle, how that strategy is implemented needs to be fine-tuned in response to market conditions.

Each portfolio we manage has an investment policy which outlines the overall strategy. These strategies are long-term and developed personally for each client and their objectives. This strategy is the primary determinate of risk and return, and it sets the major asset class allocation of stocks, bonds, and cash. In many cases, the investment strategy will be adjusted as the goal for the money draws closer in time. For example, during the years leading up to retirement a portfolio strategy may need to be updated to provide cash for withdrawals during retirement. These adjustments are not in reaction to current market conditions, but are based on the client, their life stage, and objectives.

In contrast, the implementation of the strategy should be responsive to market developments. These are more tactical decisions as markets and economic conditions change. The security selection considers what types of stocks, bond, and other assets to include, in what weight, and at what timing. Factors include risk, the need for income, and the tax characteristics. But even as the implementation evolves, the overall strategy remains in place.

In this past year there has been more need for these adjustments. Some stock positions did not respond as expected to market movements, and we selected dependable replacements. Others were not particularly problematic but not, in our judgement, worth the ongoing cost of ownership given their performance. Implementation of the bond portion of a portfolio has also changed with recent opportunities in individual bonds at their best in over a decade. We began steadily buying treasury bonds for accounts for the first time in many years. We continued to purchase municipal bonds and CD’s, all of which are offering the best yields in recent history. We are also moving more investment dollars into longer-maturity bonds to capture current higher rates for years to come.

Many portfolios hold some percentage in cash, either for gradual investment or upcoming withdrawals. As money market rates are rising to near 4%, we have moved larger cash positions into higher yielding money market funds. With cash being a necessary part of many portfolios, it can now also be a productive part.

Our overview, outlook, and possible future opportunities for many areas of the market are explained below:

U.S. Stocks – Stocks of U.S. companies are appealing—with prices and valuations much lower than last year—although susceptible to continuing volatility. Company quarterly earnings results and forward guidance will likely affect prices in the near-term more than usual. Investors are eager to gauge how management is handling the expected economic slowdown, and ultimately how that is impacting profits. Adding to quality U.S. stocks incrementally over the next six months gives an opportunity to take advantage of these lower prices. With the Federal Reserve on course to end rate increases in the first half of 2023, and eventually expected to reverse course and cut rates, the first half of 2023 may turn out to be a buying opportunity.

Foreign Stocks – While not as attractive as U.S. stocks, foreign equities can benefit from a cyclical rebound. For U.S. investors, the recent reversal of the decades-high U.S. Dollar is a significant tailwind for foreign stock returns. Emerging markets are still burdened by higher borrowing costs, but inflation and interest rates will likely moderate in several countries this year. That, along with the decline in the U.S. dollar, would boost returns in these securities as well.

Fixed income – As mentioned earlier, bonds and CDs are the most appealing they have been in years. We are taking advantage of higher interest rates to move to longer-term, high-quality bonds. The Federal Reserve has said it intends to keep short rates high until inflation comes back to a target level of near 2%. Taking advantage of short-term rates, and being fully invested in the longer end of the target bond portfolio, could be beneficial if the economy is heading toward a period of slower growth. We are cautious regarding credit quality, favoring higher quality with longer duration. We “ladder” portfolios of individual bonds with similar dollar amounts in each maturity from two years to six years. We use tax-exempt municipal bonds in taxable accounts, which are increasingly attractive on a tax-adjusted basis. Corporate, taxable municipals, CD’s, treasuries, and government agency fixed income are our choice for IRA accounts.

While we review many areas of the market, our focus when managing your portfolio is on your personal goal and an individualized strategy to reach that goal. As always, your comments and questions are welcome. Please call us or stop by the office any time.