Why investing now makes sense

Investors often try to reconcile a constructive long-term view with a more challenging short-term outlook by simply waiting. But this approach also entails risks: the savings from waiting tend to be limited, but the opportunity costs can be much greater. In our latest monthly letter, we discussed the trade-off between waiting and investing.

Central bankers are still talking tough on inflation. But over the last month, markets have moved on from worrying about rising prices. Instead, the risks of central banks over-tightening and recession have come into greater focus.

Inflation data has continued to surprise to the upside, and markets have priced in a more front-loaded rate hiking cycle by the Federal Reserve. This appears to be reducing long-term inflation fears. At the same time, growth indicators have continued to fall. US 2Q GDP contracted 0.9% on an annualized basis. This was the second consecutive quarterly decline. Business sentiment indicators are pointing to contracting activity in both the US and the Eurozone.

What does that mean for investors today?

In the near term, we think the risk-reward for broad equity indexes will be muted. Equities are pricing in a “soft landing.” But the risk of a deeper “slump” in economic activity is elevated. So, tactically, we advocate selectivity and optionality:

1. First, we tilt our equity exposure toward value, quality-income, and healthcare.
2. Second, in fixed income, we move high grade bonds, which would likely rally sharply in a “slump” scenario, from neutral to most preferred.
3. Third, in currencies, we keep a most preferred stance on the Swiss franc.

But what about investors with a longer-term view?

Consider the current environment after this year’s sell-off in equities and bonds: Equity valuations are currently at levels that since 1960 have been consistent with 7–9% annualized returns for the next decade. At the same time, the yields available in bond markets have improved significantly this year. This is a rare combination. In alternatives, analysis by Cambridge Associates shows that private equity growth funds created after sell-offs in public markets have performed better than earlier vintages.

We think this combination of equity valuations, yields, and newly created private equity vintages will mean stronger long-term returns for diversified portfolios.

Many of our clients, however, appear underdiversified and underinvested. Part of the reason for this is that, as noted above, many investors facing an uncertain outlook choose to wait on the sidelines before investing.

So, while the near-term outlook for equities might be uncertain, we believe diversified portfolios should deliver more stable outcomes over the coming months, given the market scenarios we face.

Historical data supports the idea that waiting can be riskier than investing right away. Since 1960, a strategy that waited for a 10% correction before buying the S&P 500, and then sold at a new all-time high, would have underperformed a buy-and-hold strategy by 80 times—yes, 80 times. Over the same time period, a strategy of investing immediately after a 20% drop would have delivered an average one-year return of 15%. An investor staying in cash for a year after a 20% drop would have earned 2%. This significant gap in performance also widens over time with the effect of compounding.

So, while the near-term outlook for equities might be uncertain, we believe diversified portfolios should deliver more stable outcomes over the coming months, given the market scenarios we face.

By buying diversified portfolios today, we believe investors can both mitigate near-term risks and position for long-term performance, while not running the risk of being left, potentially indefinitely, on the sidelines.

Read more in our latest monthly letter, “Why invest now?”

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