Myles Zyblock, Chief Investment Strategist of Scotia Global Asset Management – which manages over $200 billion for millions of investors in Canada and around the world – shares Scotia GAM’s latest market and investing insights.
This month, Myles discusses the underperformance of the traditional 60/40 diversified portfolio of stocks and bonds, and why alternative investments play an important role in portfolios.
Investors are confronting the dual problems of elevated inflation and slowing economic growth. By raising interest rates, global central bankers are attempting to address the first issue, but at the cost of an even more challenging economic landscape. They fully acknowledge this difficult situation, with Chairman of the U.S. Federal Reserve Jerome Powell recently pointing to the narrowing window for avoiding a recession. Meanwhile, the Bank of England’s latest projections assume a U.K. economic recession for a good portion of 2023 and 2024.
Stock and bond prices have continued to struggle, mainly due to the valuation pressures associated with uncomfortably high inflation and rising interest rates. At this stage, we cannot see any factors that would be powerful enough to sustainably reverse the current trajectory for stock or bond prices.
A substantial amount of “froth” has been removed from the equity market, meaning investors are increasingly looking at fundamentals again. Former social media darlings, or "meme stocks," newly minted initial public offerings (IPOs), and crypto-levered companies have seen declines ranging from 50% to greater than 70% from their peaks.
But it is not just the more speculative/smaller-cap areas of the equity market that have struggled. Many mega-cap tech stocks, often referred to as FAANG+ (these include tech names such as Facebook, Apple, Amazon, Netflix, and Google, as well as a few others) have been hit hard during this global equity bear market. These companies comprise a large share of major equity markets and are down by 33% (10 percentage points more than the broad benchmark). It has been difficult for the indexes to make much headway when these companies continue to struggle. While the stock price declines are opening the door to future opportunity, investors need not rush into these names until sometime after interest rate and earnings risk dissipates.
On the bond side of the equation, the downward performance pressure on the global bond market was initially instigated by surging inflation and magnified by an aggressive cycle of raising interest rates. Yields have increased from 0.8% at the end of 2020 to 3.8% more recently, resulting in a 26% decline in total return over the period. Close to $15 trillion in market value has been erased by the selloff. This is the most severe bond bear market, by far, since the global benchmark came into existence back in 1990.
While most of this bond market downturn is probably now in the rear-view mirror, historically speaking, a sustainable rise in bond prices and decline in bond yields has usually only started within three months of the time that the central bankers change their course of action. Much depends on how cooperative inflation trends are, but a major shift in central bank behaviour before the second quarter of 2023 seems unlikely, at this juncture.
What are investors to do? The traditional 60/40 (equities/bonds) balanced portfolio is having one of its most difficult performance years since 1974. While the downturn in the stock market hasn’t been nearly as bad as those seen in 2020, 2007-09, or 2000-02, the accompanying weakness from the bond market has been infrequent over the past 75 years.
While maintaining a balanced portfolio over the long term is still prudent, an increased allocation to alternative investments should also be considered.
While many investors equate alternative investments with sophisticated hedge funds and high-net-worth investors, the truth is that everyday investors now have access to an expanding range of alternative investments. While some alternative investments do use complex strategies that require extensive financial expertise to implement, there are a broad range of alternative investments that many investors will be readily familiar with, such as real estate investment trusts, infrastructure, and gold – all designed to deliver returns with a lower correlation to traditional stocks and bonds. Because they rely on alternative sources of returns – independent of traditional stock and bond markets – many alternative investments actually exhibit less volatility than traditional investments. When combined with traditional investments, alternative investments provide the potential for enhanced portfolio diversification, less volatility, and improved risk-adjusted returns.
Myles Zyblock is a recognized North American strategist, regarded for his investment insights that blend finance and psychology to capture major inflection points in financial markets. Myles has over 25 years of experience in guiding and advising on asset allocation for a diverse set of institutional and retail advisors globally. Myles joined the firm in 2013 as the Chief Investment Strategist, working closely with the Investment Team. His experience spans multiple asset classes and geographic regions.