Sunday 15 September 2019

How to manage stock market uncertainty as a bear market looms

Investor

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Paul Kenny

'The hardest time to invest is now' is a common saying in investments. While we can never forecast with certainty what is next for markets, we can learn from the past and academia. We know that markets do not post positive returns forever and that markets and economies tend to move in cycles, albeit not of a fixed length.

Following a long period of positive returns from markets, investors are focusing on the potential for a bear market ahead.

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Strong corporate earnings and relatively positive GDP growth have generally supported markets. However, downside risks appear to be rising - most notably the move from quantitative easing - where central banks keep interest rates low and pump liquidity into the global financial sector, to quantitative tightening (QT) - where central banks tighten money supply and increase interest rates. This move to QT is being led by the US Federal Reserve; however, the European Central Bank is due to start playing catch-up over the next year or two.

At best, QT will be a headwind for markets. At worst, it could damage economic growth and lead to repeated periods of heightened volatility and, potentially, a significant fall in stock markets. Bond markets are unlikely to provide a safe harbour, as rising interest rates on the back of QT will reduce the value of bond investments.

So how should investors react?

If your investment horizon is ultra-long (over 10 to 20 years), you are still a net investor (that is, where new money being invested exceeds that being disinvested), and you are not particularly concerned about short-term ups and downs in markets, the correct response could well be to maintain your current investment strategy.

Of course, lots of investors do not have this level of freedom when it comes to investment horizons and delivering on investment objectives. Now could be a good time for them to review their strategy. It could also be worthwhile to note the recent moves made by Irish pension schemes.

Irish defined benefit (DB) pension schemes have been steadily reducing their exposure to global stock markets over the last decade and, following further reductions in 2018, stock market allocations (that is, the percentage of the schemes invested in stock markets) now average around 30pc. Rather than switching into bond assets with low yields (returns), some pension trustee boards have looked outside traditional asset classes, considering investments which still target reasonable expected returns but are likely to better weather a storm in stock markets. Private-market investments such as private debt, infrastructure and long-lease property are emerging as popular diversifying options.

Trustees of defined contribution (DC) pension schemes have moved in recent years to offer members access to funds with increased diversification and downside protection (a strategy which seeks to reduce losses). This is in comparison to the more traditional approach, which tended to be overexposed to stock markets.

Individual investors may wish to review their underlying exposures to stock and bonds markets and consider what other investment options are available to them.

Long-term investing needs to be just that. That means having the discipline not to react to short-term market falls. However, it does not mean investors should do nothing. Conducting a review of long-term investment strategy now is a sensible and prudent path - and may well lead to a desire to reduce stock market exposures and increase the level of diversification and protection against severe market events, which are starting to feel increasingly possible.

  • Paul Kenny is head of investments with Mercer (mercer.ie)
  • Any investment commentary in this column is from the author directly and should not be seen as a recommendation from The Sunday Independent

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