4 Steps for Weathering a Stock Market Storm
I love watching The Titanic. I love the romance. I love the suspense. I love the emotional catharsis I feel every time I watch the film. However, just because I adore a movie about a ship sinking, doesn’t mean I ever want to be on a sinking ship. Yet, when the market whips itself into a frenzy, it can feel like we put all of our money on a doomed vessel, only to watch our money sink into the ocean as we cling to a lone chunk of wood.
As we steer our ships through this particular stock market storm, it is important to understand how to maintain and navigate your vessel, such that you arrive safe, and relatively dry, on the other side. With that in mind, let’s discuss four ways you can captain your ship for success during this storm.
Prepare for Rising Tides: The Fed has already signaled that they will continue to raise interest rates until they are sure that inflation is consistently heading in a downward direction. You should expect the federal funds rate to increase another percentage point by the end of the year, and as the cost of borrowing rises, the economy will continue to tighten. Companies will have less discretionary cash, especially if they have significant debt loads. The housing market has and will likely continue to cool off. With the waters on the rise, how can you make sure you don’t hit an insurmountable wave? For one, consider investments that are more resilient to interest rate hikes. Value stocks tend to be more resilient to interest rate hikes than are growth stocks. Additionally, income investors might look outside of the bond market. Bond valuations will continue to be rocked by interest rate hikes. Alternatively, income investors could look towards preferred stocks and Dividend Aristocrats for income with potentially less volatility than bonds are experiencing at this moment.
If you are in the market for a house, or are expecting to take on another form of debt, you can take steps to minimize the impact of interest rate increases. Spend time during the next few months tracking, and working to increase, your credit score. You can do so by making multiple payments during a billing cycle or making payments right before the end of your billing cycle. You might also consider paying for points to reduce your interest rate, in addition to shopping around with different mortgage providers. These steps can help you lock in the lowest possible interest rate in a rising rate environment.
Shore Up Holes in Your Boat. We have already seen significant stock market volatility this year, and with the Fed continuing to raise interest rates, we will likely see more. In addition, the economy is showing recessionary signs, including negative GDP growth and an inverted yield curve (where short-term rates are higher than long-term rates). While an oncoming recession might sound scary for investors, the stock market generally bottoms far before the general economy. Take our boating metaphor. If you are out at sea, bad weather will impact you and then pass long before the bad weather reaches land. Similarly, a recession will rock the stock market before the broader economy. Historically, the stock market bottomed around 6 months before the broader economy and was up 28% from its bottom by the time the economy reached its trough.
With a recession likely on the horizon, it can be prudent to look into defensive investments. Defensive sectors have historically included utilities, healthcare and consumer staples, all of which were outperforming the broader market as of the end of August. This year, energy is also turning out to be a defensive sector. While increasing your exposure to defensive sectors is potentially prudent, it is important to maintain broad sector diversification, even within sectors that are facing the stormiest weather. For example, the communications and technology sectors are down much more than the broader market, but pulling all of your investments from these sectors could hinder your long-term growth prospects. Historically, investors who bought into the market after a 20% decline saw better returns in the next 1-3 years.
Beyond considering your investment allocation, you can also prepare for a recession by shoring up your emergency fund. Making sure you have enough funds in the event of a lay off is important during tighter economic moments. If you work in an especially volatile sector, you could also consider seeking additional training to improve your job prospects if the job market becomes tighter.
Pack “quality” supplies for your voyage. While quality supplies will almost certainly include some strong dividend-paying stocks, it may be challenging to select other “quality” investments for your portfolio. A large number of exchange-traded funds (ETFs) hold so-called “quality” stocks. Depending on the ETF, quality stocks may include companies that earn larger profits, see steady earnings growth, have high cash flows, or feature any number of qualities. These “quality” companies, and the ETFs that hold them, have historically seen less volatility during a downward market cycle. During the past three decades, quality stocks regularly outperformed during volatile stock market environments. However, quality-focused ETFs haven’t necessarily outperformed this year. For one, many quality-focused ETFs are invested in highly profitable companies, such as Facebook and Alphabet. The stocks of these companies had significantly appreciated by the beginning of this year. When the market started to fizzle, investors sold off their appreciated stocks to raise cash, causing the values of these stocks to plummet. Accordingly, quality ETFs that hold these stocks are hitting a rough patch.
Additionally, as discussed above, different funds define “quality” in very different ways. As a result, it’s important to interrogate a fund’s investment objectives and metrics before investing. Additionally, it’s important to remember that historically defensive investments, such as “quality” stocks, can still underperform during volatile market moments. History does not predict the future, nor is there any foolproof way for an investor to avoid the impact of stock market volatility. Instead, maintaining diversification, researching your investments, and investing for the long-haul are still the tried and true methods for long-term success.
Don’t jump overboard when the waters get rocky. Impulsive, fear-based decisions will not be your friend. Even if the boat feels unsteady, the water is still colder and rockier. It’s important to understand your triggers. What prompts you to head towards the boat’s railings? Some common triggers include reading doom-and-gloom news articles and obsessively checking your investment balances. Once you have identified a trigger, develop a plan for when you feel your heart begin to race. Do you need to call a friend for support, someone who will remind you that the world won’t end tomorrow? Do you need to eat a meal or go for a walk? Design your plan in advance so that you aren’t having to plan when you are in fight-or-flight mode.
However, it is also important to listen to your fears. When they come up, write them down or tell a friend. You can then return to your fears when you’re in a more level and even mood. Your logical brain goes offline during fight-or-flight, impeding your ability to make helpful decisions. Once you’ve calmed down, you can develop a stronger action plan than you would have been able to while in fight or flight.
If Elm3 manages your investments, please remember that you are not weathering this storm alone. We are checking the weather, changing course, and shoring up holes as necessary. With some prudence and persistence, we can make it to the other side together.
