Last year’s abysmal market performance, across nearly all asset classes, may be heralding a new era of lower, less predictable returns. After six years of solid stock market profits (S&P returns of over 17 percent annualized from 2009-2014), the completion of the Fed’s unconventional monetary policy called quantitative easing (QE) did little to support already fully valued asset prices. Enormous debt growth, especially among emerging markets, and the demise of the commodities super cycle have generated a degree of angst among investors and speculators not seen since the Great Recession. The important work of helping clients to remain disciplined and engaged throughout corrections cannot be overestimated. Behavioral coaching—along with a bit of guile—can go a long way toward saving clients from themselves.
What does 2015’s performance mean for future investment returns? Has unconventional monetary policy pushed asset prices above sustainable levels? Could the Fed’s QE unwind pressure asset prices for the next several years as early 2016 may be indicating? Lastly and perhaps most importantly, is there a worldwide credit/commodity recession unfolding? And if so, what does it mean for the U.S. economy and future stock returns?
Now that the unwind phase of QE is at hand, deflationary pressures may well reassert themselves. No one really knows. The process whereby QE purchased securities mature, known as tapering, may diminish market liquidity and offset the Fed’s extensive easing efforts of the past several years. With few recent data points to draw from, deflation is poorly understood by most advisory practitioners. What’s more, the Fed’s recent focus on eliminating the threat, may have served to postpone deflationary pressures, making identification all the more difficult.
Growing market volatility and a newly emergent “risk off” mentality initially in energy and highly leveraged financials is spreading to other vulnerable markets. The slightest earnings disappointment or adverse narrative is now grounds for a thrashing from disappointed traders and short sellers.
Portfolio Management Best Practices
One of the more important, yet vexing, issues for most advisors revolves around appropriately defining and managing the risks specific to each individual client. Spending time to understand client risk tolerance including time horizon, age and income needs is essential. Risk varies by client circumstance and market environment, so it can be a moving target. To some, diminishing risk means avoiding significant portfolio price declines (asset value volatility) while to others it’s about having sufficient lifetime income (sustainable withdrawals). Developing and maintaining the appropriate risk tolerance framework during a correction (or bear market) is a conundrum requiring time, effort and an ongoing commitment to client communication.
Arriving at a suitable asset allocation and retaining that mix throughout a correction is the most important determinant of long-term performance. Discipline and consistency within a portfolio is essential. Regrettably, a client’s commitment to necessary risk assets can disappear rapidly during market corrections. Once an allocation is in place, maintaining a long-term focus throughout the correction will help limit short-term distractions and behavioral blunders.