Equity prices are high, the next interest rate hikes are imminent, and the war in Ukraine and sanctions will have a negative economic impact. How should investors position themselves against this uncertain backdrop?
In this installment of our “3 Questions for...” series, Thomas Wille, LGT Chief Investment Officer for Europe, explains what should be kept in mind in the current environment.
1. Should investors sell stocks in the current environment and drastically increase their cash allocation; in other words, should they keep their powder dry and then re-enter the stock market when prices have come down?
As a general rule, we recommend that investors stick to their long-term investment strategy in any environment and that they not attempt to implement any large-scale short-term market timing strategies. In the current inflationary environment, real assets should be given clear preference. Cash has a nominal value. So, in the best case, it generates no return, and in the worst case, you pay negative interest on it. With inflation rates of over eight percent in the US and over six percent in the eurozone, a high cash allocation is therefore not the best alternative for a portfolio – unless it serves as a prudent liquidity reserve. For equities, the current, rather high valuations, mean that they have to be selected carefully. We recommend focusing on quality and value stocks with sustainable dividends.
2. Inflation is increasing at a record rate and central banks are discussing interest rate hikes. Does it make sense for investors to reduce their bond allocation in favor of cash, and to only start buying bonds again when bond interest rates increase so they lock in the higher rates?
No, what I said earlier also applies here: the individual investment strategy represents the optimal mix. Like cash, bonds have a nominal value and are thus directly exposed to inflation. But, depending on the individual risk profile, it still makes sense to have a certain allocation to bonds. However, this should be monitored and actively managed. For example, certain bonds with long times to maturity could become increasingly attractive in the near future. In addition, attractive niches currently exist in the bond segment, but they are very thin on the ground. You need to know the market very well if you want to take advantage of that.
3. Should investors try to benefit from anticipated market developments by making tactical adjustments to their investment strategy, or is the risk too great that they will behave like “the rest of the herd” and generate losses?
Tactical adjustments essentially mean deviating, within certain ranges, from the long-term strategic asset allocation in the short term. For example: if the investment strategy calls for a strategic equity allocation of 40 percent in the portfolio and you expect stock markets to perform very positively in the short term, you can tactically increase this allocation to 45 percent and then reap the benefit if prices do in fact increase. Tactical deviations from the strategy can thus indeed have positive outcomes, but you should proceed very systematically and without emotion. If you act without a clear plan, and especially if you don’t define buy or sell limits, you run the risk of generating losses. In today’s interconnected world, markets can move in the wrong direction for extended periods – often longer than investors with weak nerves can endure. In such cases, they frequently buy and sell at the least opportune time.
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