Global Investment Strategy
August 31, 2015 (Weekly Update)
Tracie McMillion, CFA®, Head of Global Asset Allocation Strategy
Weekly market insights from the Global Investment Strategy team
- Equity markets frequently experience short-lived downturns that, in retrospect, often prove to be good buying opportunities.
- Rebalancing to established target asset allocations during market downturns is a good way to “buy the dips.”
What it may mean for investors
- It is not too late to overweight U.S. Large-Cap stocks and Developed-Market equities.
Buying the Dips
Investors frequently tell us that they want to buy the dips in the stock market—and with good reason. In the chart below, we see that at some point during each of the last 35 years, the S&P 500 Index has experienced a negative return. By year-end, however, returns had turned positive again 80 percent of the time.
Chart 1. Market Corrections and Annual Returns
Source: Morningstar Encorr as of 12/31/2014. Past performance is no guarantee of future results. Severe intra-year corrections do not necessarily indicate sub-par performance for the calendar year. Analysis was compiled using the S&P 500 Price Index. The S&P 500 Index is a capitalization-weighted index calculated on a total return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies. An index is unavailable for direct investment
Even though relatively short-lived dips occur fairly frequently, when they do occur there are usually valid reasons to wait to invest more heavily in stocks. Last week was no exception. With equity markets down six percent or more in just two days and the S&P 500 Index officially entering correction territory for the first time in nearly four years, worries about global growth held many investors back from committing more capital to stocks.
So, you may be wondering, what is the best way to take advantage of market declines? Because it is psychologically challenging for most market participants to invest when markets are falling, planning ahead of time for these volatile periods may be the best way to overcome a reluctance to invest in the heat of the downturn. If you are holding cash, investing that cash on a regular basis is a great way to purchase more assets when prices are lower and fewer assets when prices are higher. But with cash yielding near zero percent, holding short-term bonds or other high-quality fixed-income assets may be a practical way to enjoy some income benefit while waiting for an opportunity to invest in other asset classes like equities or real estate investment trusts (REITs).
Higher quality bonds have also tended to hold their value better during market selloffs. At the height of this week’s selloff, for example, these types of bonds increased in value. Generating some income and stabilizing your portfolio value in times of market unrest are two reasons why bonds may make an appropriate addition to an equity portfolio. Another sound reason to hold them is as a source of funds when equity markets fall in value. If you set a target allocation to bonds, equities, real assets, and alternative investments like hedge funds, ahead of market volatility, you can use market corrections as opportunities to rebalance (also known as buying the dips!) Rebalancing back to your target allocation can take the emotion out of the decision, allowing you to potentially benefit from market volatility.
Fortunately, anyone who waited to buy the dip last week still may have an opportunity to buy into a lower overall market. That’s because despite the market stabilization that occurred during the week, most equity markets are still well off their all-time highs. It is our view that this decline is a relatively short-lived dislocation not a more troubling start to a bear market. However, we do expect volatility to remain elevated over the next few months as we go through a cyclically weak period in the markets and as we approach a possible increase in the Federal Reserve’s target interest rate. We suggest that investors consider rebalancing to target allocations and use this opportunity to overweight U.S. Large-Cap stocks and Developed-Market stocks. Funding for these over-weights could come from our underweighted asset classes in the Fixed-Income asset group, including High-Yield, Developed-Market and Long-Term Investment-Grade U.S. bonds.
Tracie McMillion is the head of global asset allocation strategy for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
In her current role, Ms. McMillion leads the development of global investment strategy. She oversees the creation of asset allocation recommendations and writes economic and market commentary and analysis. Ms. McMillion has been quoted in The Wall Street Journal and Barrons, on CNBC, and in other financial media outlets.
Ms. McMillion has more than 18 years of experience in financial services. Prior to her current role, she served as an asset allocation strategist and a senior investment research analyst for Wells Fargo and predecessor firms. Earlier in her career, she served as lead portfolio manager for Evergreen Private Asset Management where she managed assets for high-net-worth clients and philanthropic organizations.
Tracie earned a Bachelor of Arts in Economics and a Master of Business Administration from the College of William and Mary in Virginia. She is a CFA® charterholder and member of the CFA North Carolina Society. Ms. McMillion is located in Winston-Salem, North Carolina.
*As of Sept. 30, 2014
All investing involves some degree of risk, whether it is associated with market volatility, purchasing power or a specific security. Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments.
Some alternative investments and complementary strategies may be available to prequalified investors only. Hedge strategies and private investments may be speculative and involve a high degree of risk. Hedge strategies and private investment performance can be volatile. An investor could lose all or a substantial amount of his or her investment. There is no secondary market for the investor’s interest in a hedge fund or private equity investment and none is expected to develop. There may be restrictions on transferring interests in a hedge fund or private equity investment.
Investments in fixed-income securities are subject to credit and interest rate risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity.
There are special risks associated with an investment in real estate (REIT’s), including the possible illiquidity of the underlying properties, credit risk, interest rate fluctuations and the impact of varied economic conditions.
Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns.
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