As the world reckons with a pervasive cost of living crisis and the Federal Reserve all but promises additional interest rate increases, it’s clear that certain problems posed by inflation are not going anywhere anytime soon. The continual volatility of 2022’s market has been defined largely by the highest levels of inflation seen in decades, disrupting the economy as well as investment professionals’ ability to consistently deliver above-average returns for clients.

Considering the current state of the market and its outlook for the foreseeable future, investment firms should be considering a meaningful shift in approach to portfolio management. After several years of mounting returns that were reliable and seemed to have no limit for potential growth, the investment sphere is overdue for a move towards pragmatism and de-risking.

However, effectively preserving clients’ assets in this environment requires an understanding of the myriad factors that brought us here in the first place. 

Chief among them was the pandemic: as COVID-19 reached an inflection point in 2020, markets dipped due to the collective fear that gripped the financial sector and the world at large. As businesses shut down and people were put out of work, unemployment rates skyrocketed overnight. Although it may be hard to remember now, fears of a full-blown recession were pronounced even amid the momentary market fluctuations of 2020.

However, as conditions stabilized and the economy adjusted to this new reality, the market rebounded. Companies went virtual, families stayed home, businesses received COVID-19 relief funds, and people learned how to conduct transactions in a socially distanced fashion. The Fed’s emergency intervention and multi-trillion cash infusion proved especially pivotal: as interest rates were lowered to zero, funds were sent to individuals, and financial instruments—such as government, corporate, and municipal bonds—were purchased, the economy suddenly found itself flushed with cash. The Fed’s injection of liquidity made consumers feel comfortable spending again and provided investors with access to capital that was then put back into the market.

For many individuals, this market stabilization and flood of federal government-supplied cash served as a proverbial green light from the Fed to buy risk-based assets of long duration: a considerable amount of this newfound wealth was spent on new and volatile asset classes such as crypto, meme stocks, and tech investments. Even with ongoing issues like supply chain woes, the economy had seemingly found a place of relative stability in an unstable world.

But as 2021 progressed, keen observers began suspecting that the market was due for a correction. Stocks of companies with very little in the way of earnings or even sales were performing significantly better than entities with predictable earnings and cash flow, making it difficult to ascertain the fair value of more speculative companies in the market, a tricky prospect made even trickier by low interest rates. With more and more speculative stocks providing an overvalued gauge of the market’s conditions, many felt overly comfortable diversifying with excess capital. As more and more investors took risks without realizing they were putting their portfolios in peril, some firms took steps to reengineer their assets and insulate themselves from stocks that were particularly susceptible to high interest rates.

Flash-forward to 2022, and any notion of economic steadiness has all but vanished. The latent issues facing the market have since become readily visible, with record-high inflation and stagnant growth as the most overt symptoms. What’s more, exogenous variables such as the war in Ukraine and further supply chain troubles spurred by new COVID waves have exacerbated existing problems while the Fed has completely pivoted on its previous reluctance to raise interest rates above zero and wrestled with an ever-expanding balance sheet. Now faced with frayed nerves in the financial sector and beyond, the Fed’s aggressive increase of interest rates has only amplified the anxieties swirling around the economy.

Now, with two consecutive quarters of GDP decline amid dim forecasts of lower earnings, corporate margins, and higher interest rates, investors are fretting over how to reorient their portfolios and salvage their assets. The bitter truth is that the window of opportunity for cushioning assets against economic volatility closed several months ago. As the market undergoes a comprehensive repricing in anticipation of interest rates climbing to as high as 3.75% or 4% heading into 2023, trading is set to slow down. Neither inflation nor the Fed’s fight against it are anywhere near finished, leaving many investors caught in an interminable rut.

However, it is still possible to change course and reorient portfolios around long-term strategies. Given the current economic outlook, it’s critical to keep relative performance in mind – the overall downturn makes it difficult to imagine developing a portfolio where investors are going to be making significant returns. Although this development will prove disappointing for many, the reality is that counting on fixed income within the 60/40 model is no longer viable nor reliable for most portfolios. Instead, investors and firms ought to consider pivoting to strategies prioritizing dividends, fundamental growth, dividend growth, and qualified tax efficiency. Buying shorter duration, consistent, dividend-paying stocks brings in spendable cash and lowers risk, a winning strategy by any investment metric.

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