This change of approach calls for a change in how investors navigate declines and rallies. Rather than looking to trade stocks during short-duration dips – a practice that had been rewarded in previous economic cycles—nvestors should instead be thinking about selling excess rallies and repositioning their portfolios around sectors that are more likely to withstand a slower economy and higher interest rates. During these rallies, people should use the opportunity to substitute investments carrying higher risk with assets carrying relative risk and asymmetric possible returns. In a market as volatile as this one where it may be difficult to assess stock valuation, a portfolio asset with 10% possible downside and possible 30% upside can prove invaluable. While the market and asset valuations may take distressing blows, this asymmetric approach goes a long way toward achieving better relative performance.
Clients and investment firms looking to recalibrate their portfolios need to adopt a holistic approach when taking stock of the market. Filtering investments through a lens of risk mitigation means selecting stocks with consideration for their consistency in operational execution, beyond the strict framework of index numbers. This requires assessing which companies will fare best in the current economic environment, considering what part of the economic cycle we’re in, and in turn, investing in the industries that are broadly meeting the market’s needs. Companies with sufficient cash flow and lower payout ratios in their dividend yield can survive these lean periods better, and as a result, serve as vital backbones to a durable portfolio.
For example, Advance Auto Parts stock has remained relatively steady compared to other vendors. In light of rising financing rates, inflation and the current used car shortage, consumers are holding on to their vehicles for longer periods of time. This means more servicing, additional maintenance, and an ever-increasing demand for parts spanning brake pads and batteries to tires. In addition to boasting a consistent user base, sales to professional auto mechanics recently accounted for roughly 60% of total net sales, providing multiple avenues for uninterrupted business.
Likewise, given how much the pandemic shaped much of the present economic landscape, logical reasoning holds that it’s worth investing with enterprises that have thrived by providing necessary services in the Covid era. This includes companies like Microsoft, which derives its revenue from multiple streams spanning entertainment, technology, and digital security. Microsoft is among the entities that’s benefitted from the staying power of hybrid work, with more than 50% of its earnings deriving from cloud services and Microsoft 365 programs.
Although it may be too late to stave off the ripple effects of 2022’s market volatility, asset diversification and risk management is always a worthwhile investment. Regardless of whether the economy takes a sudden turn toward stability or not, both investment firms and clients will find that it pays more to be proactive.
Bob Kalman is co-founder and senior portfolio manager at Miramar Capital.