Investment Questions to Ponder in 2022

Though you may not remember as far back as the beginning of 2020, both the economy and investment markets were in cruising along like a family headed down the expressway to summer vacation at the beach.  And then suddenly…well, COVID struck.  The impact of the pandemic and the response by our government and others around the globe were significant.  As we begin 2022, we will have to contend with some of the effects of those responses.  To understand how we are doing this, David Jeter, CFP®, one of Allegheny Financial Group’s principals, spent time with Joe Clark, CFA, and Nick Lewandowski, CFA, from Allegheny’s Research Team to ponder questions about 2022. 

2022 is an election year.  How should an investor prepare their portfolio for this?

Joe Clark, CFA

Markets hate uncertainty, and that’s what elections present. During previous midterm election years, the S&P 500 has been roughly flat with periods of volatility before the election. After the election (when there is certainty), the election becomes a catalyst, leading the market higher.

Regarding how to prepare a portfolio, there’s really nothing you should do. Suppose there is a volatile period before the election. In that case, use that time as an opportunity to rebalance, or if you are able, contribute to buying equities at a lower price.

Overall, markets do not care which party is in Congress or the White House. Strong rallies and bear markets have happened with various parties controlling Washington. Politics should never be a factor when making investment decisions.

Nick Lewandowski, CFA

I never advise anyone to make portfolio changes based on election forecasts or results. I have seen individuals make disastrous decisions about investment allocations because they believed the market would crash under the Obama, Trump, or Biden presidency, or various mid-term elections in between. In some cases, this has delayed or destroyed these individuals' retirement plans.

Our economy and financial markets are simply more complex than a straightforward, actionable relationship between which political party is in power and investment performance. Of course, election outcomes can have real economic impacts. However, modeling how these will impact specific investments and over what timeframe(s) is a challenging exercise, to say the least. I have yet to meet a successful professional investor who can reliably do this (and who has a verifiable track record to back it up). 

We hear about the market hitting all-time highs.  Does that mean a correction is about to happen?

 Joe Clark, CFA

There is no correlation between all-time highs and market corrections. Corrections are normal, just like the market hitting new highs. Corrections typically happen every year, with the average annual drawdown being around 14%. When corrections do occur, use them as a buying opportunity rather than a time to panic. 

Nick Lewandowski, CFA

I agree with Joe.  Markets routinely hit new highs without corrections, and there is nothing directionally meaningful about the fact that markets are hitting new highs.

Inflation may stick around at much higher levels than we have experienced over the past decade.  How does one “protect” their investments?

Joe Clark, CFA

Quality equities offer the best protection against inflation. These are companies that possess competitive advantages in their industry; therefore, they have the pricing power and the ability to pass at least some of the cost increases onto consumers. As the best companies in their industry, they should continue to perform well in an inflationary environment.

High growth, momentum stocks are the ones that are underweight during an inflationary period. These stocks are trading high because their valuations are justified in a low-rate environment. As rates rise, traders question whether those companies are worthy of higher valuations, leading to falling share prices, as we saw during the first week of 2021.

For investors with a higher bond allocation, introducing inflation-protected strategies or real assets would be beneficial. Other than high growth equities, bond investments will see the most challenges in an inflationary environment.  

Like other environments, these changes should be made at the margins. Your financial advisor has built a portfolio to meet your long-term needs no matter what the market might be doing. Minor changes could benefit a portfolio, but major changes can negatively impact and risk not meeting long-term goals.

Nick Lewandowski, CFA

Asset allocation is critical here. Over the long term, inflation poses the greatest risk to the purchasing power of cash and bond investments. Therefore, portfolios heavily weighted to these asset classes are the most vulnerable to structurally higher inflation. For these portfolios, you can speak to your financial advisor about potentially including inflation-linked bond strategies, such as Treasury Inflation-Protected Securities (TIPS) or other forms of real asset exposure in your portfolio. A financial advisor can evaluate this decision in the context of your unique goals and circumstances. 

However, even if some inflation protection is suitable for your portfolio, it is essential to maintain balance and diversification within the overall asset allocation.

We build portfolios utilizing mutual funds with managers who pick companies to invest in and don’t just own an index.  How do these managers adapt their portfolios to consider inflation, market highs, and election years?

Nick Lewandowski, CFA

Managers who are primarily concerned with finding attractively priced companies will consider some of these variables when evaluating specific investments. For example, in certain sectors, particularly the financial and healthcare sectors, regulatory policy can significantly impact the economics of those companies. This is one of the few instances where an election result directly impacts which portfolio companies a manager chooses to own. 

For managers focused on stock picking, new market highs are irrelevant in and of themselves. These managers are focused on the trajectory of corporate earnings growth and the degree to which that is reflected in current market prices. Managers who trade securities entirely based on price momentum and price trend do exist. However, these strategies are purely price-based and altogether unconcerned with economic growth, inflation, and politics. Allegheny advisors do not typically use such strategies in client portfolios. 

Of course, just because a manager is making active decisions about risk exposures doesn't mean that manager will be correct. Or that those decisions will have a significant impact on performance versus an index fund. While our Research group is focused on identifying active managers with sound processes and differentiated performance, all managers (and indeed all portfolios) will go through periods of relatively stronger and weaker performance. This is why we come to sound like broken records when it comes to focusing on the long-term and sticking to a plan!

Joe Clark, CFA

Each portfolio manager has their own investment philosophy and process. Some will react to macro factors; others will not. Elections are the one factor most managers will not consider. Even the best forecasters cannot predict politics. As we said above, politics should not be a consideration for client portfolios, and the same goes for mutual fund managers.

Inflation and valuations could be considered based on the manager. Some managers are more valuations conscious, so if a stock continues to trade higher, managers will make sure they still see upside and a benefit to holding the stock. Inflation can be considered for some managers more than others. They will look to answer questions like: can a company pass rising costs to consumers? If not, how much will rising costs impact their margins and earnings, and how does this affect their stock price?

One reason client portfolios are a combination of many different managers is to diversify not only of asset classes but also investment philosophies. Depending on the environment, some managers will be outperforming, while others underperform. This dynamic provides clients with less volatile returns over the long term and allows the down markets to not feel as bad as the overall market.

Thank you, Joe, and Nick. 

The investing environment is always complex.  A good financial advisor will guide you to focus on the things in your life that you can control and minimize the energy you spend on the things you can’t.  This doesn’t mean you aren’t aware, only that you keep issues like elections, interest rates, and inflation in a proper long-term perspective.

---

Author: David Jeter, CFP® | Partner & Financial Advisor | Allegheny Financial Group | January 2022

The information included herein was obtained from sources which we believe reliable. The views in this article are being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.

Allegheny Financial Group is a Registered Investment Advisor. Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.