“We should always start by recognizing that no one can predict the future with precision. With myriad possible outcomes and often unforeseen variables, our investment philosophy is driven by avoiding the dire consequences that can result from being overly confident in a market forecast.”1
What does that mean? We think it means thoughtful diversification, fundamental analysis, proper planning, and exposure to unique strategies that can help reduce the natural impulse to panic during periods of market stress.
As humans, it is in our nature to worry, protect ourselves, and act when threatened. This goes for all aspects of our lives, including our investments. Intellectually, we all know the “stay the course” mantra is almost always the proper advice, but behavior is hard to fix. “When people say they’ve learned their lesson, they underestimate how much of their previous mistakes were caused by emotions that will return when faced with similar circumstances”.2
Here we go again…another COVID-19 variant and another bout of market volatility.
It would be dishonest to pretend like we have a clear understanding of the Omicron variant at this stage. Even the foremost experts have more questions than answers. That said, here is what we think is most important.
Delta-variant is the best playbook
Like we saw in the third quarter – there was an economic growth scare and investors huddled into the perceived safety of large-cap and technology stocks. After this brief period, the focus shifted to fundamentals, which continued to be very strong. As this occurred, investors began to refocus their portfolios on areas that would benefit from an economic recovery. For now, we think this is a reasonable road map for the Omicron variant, as initial data points in terms of virulence and vaccine efficacy are positive.
We’ve asked ourselves whether the underpinnings of further stock market gains have changed. Does Omicron impact earnings expectations for 2022? Probably not. Do we think people are going to stop traveling, going to NFL games, or attending concerts? No, we don’t. Are lockdowns still politically viable? Certainly not in the United States. Our tool kit to deal with the virus keeps growing – more people are vaccinated, boosters are being administered, treatments like Pfizer’s anti-viral pill are emerging, and the science is moving fast to deal with the inevitable evolution of the virus. There is a desensitization cycle associated with each new wave – people’s activity is impacted less and less. We believe this will be the prevailing narrative of the current variant.
This doesn’t mean market weakness is over
Before news of a new COVID-19 variant blitzing our phones, computers, and TV screens, the stock market was weakening under the surface. Last Friday, for example, the average stock was already down 13%. The market hasn’t checked back to its 200-day moving average (a technical support level) since June 2020, and investors may have been looking for a reason to take some risk off – people taking profits into year-end, Fed tapering…who knows? The 200-day moving average is 6% below current levels. If reached, that would be about a 10% drop from the highs – a run-of-the-mill correction by historical standards.
Our philosophy in practice
The question during any significant market event is always – how are we responding? The answer is we are doing what we always do – relying on a proactive approach to managing our client’s portfolios versus trying to guess about the near-term fluctuation of market prices.
At Bryn Mawr Trust we build multi-asset class and multi-manager portfolios using an “open architecture” approach. This means we believe in taking the best of our internal research process and combining that with proven outside funds. This approach allows our clients to benefit from the specific skill sets of numerous research teams, all combined in one carefully constructed portfolio.
We use our research process to identify truly differentiated strategies for our portfolios. During our manager selection and portfolio construction process, we are careful to introduce investments that we believe are uncorrelated. Negatively correlated assets can be even harder to find, especially as correlations increase during a market crisis – when things get bad, everything tends to go down. For example, from 2006 to 2019, bonds had a -0.30 correlation with equities. However, during the Financial Crisis, that correlation turned positive.
Amid our persistent search for true portfolio diversification, we have been able to identify certain strategies that we believe create a more resilient return stream. In our recommended portfolio allocation, ABR’s dynamic volatility strategy is a great example. By systemically shifting between S&P 500 and VIX futures, this manager has successfully provided negative correlation to stocks during market crises, while still allowing for participation during strong stock market periods.
Diversification is our best weapon against our inability to predict the future with precision, allowing us to build portfolios with targeted exposures that protect against the common behavioral mistakes made by investors.
Trading around unknowable outcomes such as the evolution of COVID-19 is a losing strategy. Let’s not forget, many that got the virus call correct in late March of 2020 (accurately forecasting that COVID-19 would be a global pandemic with long-lasting negative implications) got the market call very, very wrong (S&P 500 +105% since March of 2020).