April 2022
With the world in flux, it’s natural to feel anxious about the future of your investment portfolio – Omicron is surging like a tsunami, Russian troops are storming the Ukrainian border, inflation is soaring, stocks are tumbling, and central banks are tightening their grip.
Amidst all of this fear and uncertainty, what should investors do to protect themselves?
After enjoying a strong bull market since March 2020, markets have come back down to earth. From their recent peaks in late 2021 to early 2022, the S&P 500 was down as much as 9 percent in January, the NASDAQ 16 percent, the FTSE 2 percent, and the Euronext 100 around 5 percent. While stocks partially recovered towards the end of February, they could easily dip again.
Meanwhile, inflation has gone stratospheric, defying the moderate forecasts of experts. In the US, inflation was up at 7.5 percent in January 2022. In the UK in December 2021, inflation was 5.4 percent, and 5 percent in the Eurozone.
Inflation rate in the USA and Eurozone (2012-2022)
Source: Statista
Supply bottlenecks and increased demand may have kickstarted inflation, but now, the real danger is that increased inflation expectations may become a self-fulfilling loop. If this happens, producers, consumers, and workers will all suffer, and the economy and markets will bear the brunt.
This threat of runaway inflation has made central banks hawkish. The Federal Open Market Committee (FOMC) has raised interest rates in March with at least six more to come this year. Even the European Central Bank (ECB) is considering lifting its rates. ECB rates may even be positive in 2023!
Higher interest rates will temper recovery from Omicron once it has crested around the world, and they are already weighing heavily on the NASDAQ and growth stocks.
It’s important to remember that corrections and bouts of inflation are a normal part of the stock market life cycle. The S&P 500 alone experienced 11 corrections since the turn of the century.
But what is surprising is that many investors are doing themselves and their retirement funds a disservice by not preparing properly for these inevitable corrections.
We are not talking about active stock management, cycling between growth and defensive stocks. These moments are difficult to time. Rather, the focus is on building a well-diversified portfolio that provides returns in all seasons.
“Diversifying well is the most important thing you need to do in order to invest well.” – Ray Dalio
Traditionally, the main method for diversification has been allocating funds across different asset classes. For instance, investors would mix in some gold, corporate bonds, government bonds, and cash into their portfolios, rebalancing when needed as they approached retirement. Such a strategy has become easier with the proliferation of commodity and bond ETFs.
But this strategy is not as sound as it once was. Correlations aren’t a guarantee, and certainly not forever, as they change over time. Since 1997, and until recently, bonds and stocks have been moving in opposite directions. But over the last year, the correlation has moved into positive territory.
Gold, government bonds, and cash remain the ultimate safe havens for risk-averse investors, with the trade-off of lower returns.
Some see Bitcoin as “digital gold,” which can hedge against movements in the stock market while also delivering large returns. However, in recent months, Bitcoin, too, seems to be moving with stocks, and its price is extremely volatile. Yet, as with gold, Bitcoin still retains its inflation-fighting properties.
Surely there must be a better way?
Enter Ray Dalio, CEO of Bridgewater, the largest hedge fund in the world, with USD billion in assets under its management. After nearly losing it all in the 1980s, Dalio rose from the ashes with a new mantra that he calls the “Holy Grail of investing”: find 15 to 20 good quality uncorrelated income streams. By doing this, Dalio has shown that you can make reliable returns while significantly reducing risk. His hedge fund is proof of this winning strategy in action.
