If you've been stressed by the downward market moves over the past few weeks then perhaps your risk position is too high. If you've been overly happy about the downward moves, then perhaps you haven't had enough risk on the table. Everyone is a genius when markets are rising, it's only when they fall that sober perspective is (sometimes) achieved.
Will the markets fall or rise? Despite extensive media coverage of 'experts' nobody really has a clue (especially the economists and sell-side commentators!). Asset pricing is not an equation based science, it's a dynamic and recursive loop between the real economy, macro policy actions and asset prices which feed off each other and are distorted by politics, greed/fear appetites, imperfect information frameworks and countless known/unknown variables. Had you known about covid-19 in 2019, could you have guessed the current level of markets or its price profile in 2020?
Having said that, there are some intelligent guesses/observations to be made about the future.
Difficult politically for any democratically elected government to cut spending quickly to reduce the huge budget deficits. But with little to no growth, deficits need to be reduced (or inflated away). This will negatively impact economic activity and real return of assets
Developed countries' central banks have limited scope to adjust interest rates. The blow-off valve will therefore fall on currency exchange rates
Credit creation likely to be constrained and alongside already low rates, it will be difficult to further stimulate economies. Governments will probably try anyway but it will be paid for in other ways (currency, Japan style asset deflation?)
There is policy and market complacency towards inflation. General consensus that there will be little to no inflation is precisely the reason why this fat tail risk is likely under-priced
Low interest rates have pulled forward asset valuations. While rates are unlikely to move upwards much in absolute terms, the relative magnitude of interest rate changes will be big
The next few years is likely to be challenging for the real economy. It could be a period of unexciting real growth deterioration in the West while financial markets may see sudden bursts of volatility (e.g. changing taxation policies, gov spending, FX, etc). Conditions are ripe for a historical tipping point of regime change. It will be an excellent period for skilled Active investors while Passive investors may find broader Indexes to be unexciting to poor - the era of momentum investing and banking on asset appreciation from falling interest rates is near an end.
Breaking investment returns into: 1) valuation multiple appreciation, and 2) earnings growth; I think valuations are already at their limits and have significant downside risk from rising discount rates and companies failing to meet high growth expectations. At this juncture I would much rather be in a boring but high cash-flow and ignored company than in an exciting, high growth, front page headlines company. Professional investing is like professional gambling: it's more about picking the most attractive odds and less about guessing the winner. Betting on the house favorite horse is almost always a long term negative payoff event.
For the portfolio I intend to maintain at least 20% cash dry powder and likely to keep rolling my Put spreads with increased duration. On stock selection preference:
Prefer Value over Growth. I hate using this distinction but its probably the best description in today's extreme markets. This could be discount to assets e.g. oil & gas companies with substantial low cost reserves, Hasbro with its under-monetised IP library and channels; low to reasonable cash-flow multiples (on normal earnings) e.g. tobacco companies
Prefer to have intrinsic risk exposure over extrinsic within stock prices e.g. Spirit Aerosystems, Bayer, Euronet. I'm far less keen on investing in popular thematic ideas like technology, electric cars, semi-conductors, etc which has a popularity market premium built in. In today's world I feel many dreams are priced more highly than reality
Owning companies with pricing power (usually reflection of mature competition landscape) and structural underlying real growth
Owning inflation protected assets. If and when inflation hits, the premium for this protection will jump significantly because its not expected
More emerging Asia than West exposures. This is simple: 1) underlying growth that's less reliant on increasing consumer leverage to achieve, 2) higher interest rates and lower valuations. This may not be the domestic China A-share market today (which is goldfish bowl for capital and probably in some bubble territory today) but many China listed shares in Hong Kong do look cheap
I am always worried about a market crash but now more so than usual. When I see 20 something year olds selling their get rich stock tips on YouTube talking about the new world order, cult tech companies split their stock only to see prices surge (looking at you Tesla), it's a pretty good signal that the retail investor bandwagon party is in full swing. The post US elections hangover could be interesting to watch.
PS
This post's cover picture is a cow, not a bull.
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