Is Your Head Spinning yet?

The market action over the last week or so has been so crazy that many participants are likely suffering from seasickness. It has given me the feeling that I’ve been on a monstrous roller coaster of just ups and downs with no extended straightaways. How about you? There are so many inputs that need to be factored into the decision to buy or sell the US equity market, but have things really changed that significantly since Thanksgiving let alone every day? Sure, we have the new Covid-19 strain called Omicron, but as of today we really don’t know how much we will be impacted by it. Yet, with each piece of “information”, the markets rapidly adjust (overreact). Is it rational behavior? Given underlying valuations for US stocks… are holders of equities just looking for a reason to sell or are we seeing long-term investors using every opportunity to buy dips? I guess that only time will tell.

However, if your head is spinning and you aren’t sure about the near-term direction of your equity exposure I would encourage you to look to your Investment Policy Statement (IPS) for guidance. Take advantage of the tremendous gains created during the last 18 months to rebalance your pension asset allocation back to policy normal targets. It is never a bad time to take profits! Furthermore, if you believe, as we do, that US interest rates need to eventually reflect the current economic environment, you may also want to change the composition of your fixed-income allocation.

A rising US interest rate environment will create significant headwinds for your total return-oriented manager. It doesn’t take much of an interest rate move upward to create a negative annual return for your manager. In fact, at these low-interest rates, only a 30 basis point move up in rates would have a 7-year duration portfolio producing a negative annual return for your bond manager. That can happen in a week or less! Consider adopting a cash flow matching fixed income (CDI) implementation that matches asset cash flows from bonds (interest and principal) with liability cash flows. A CDI strategy will ensure that your plan’s liquidity is enhanced, interest rate risk on that portion of the portfolio is mitigated, and importantly, the investing horizon for your growth assets is extended allowing for those assets to grow unencumbered.

Adopting this approach will likely reduce the seasickness that you may be experiencing at this time. Securing the plan’s liabilities (the promise to participants) should be the primary objective, which can be accomplished at a reasonable cost and with prudent risk. Save the ups and downs for your next visit to Six Flags.

Remember… trends don’t wait for the end of the year to happen!

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