Keep Your Powder Dry … for Now

The bear continues to rampage through global financial markets, but it might finally come to a frenzied end in the next few months. 

A combination of rising interest rates and weaker corporate profits may push this bear into a period of increased market volatility. That means investment discipline, more than ever, is critical to wealth preservation and long-term growth. 

Diversification is central to that discipline, and investors should remember two things:   

• A well-diversified AMG portfolio is designed to generate wealth preservation and growth commensurate with long-term goals and risk tolerance. In other words, portfolios are balanced to help investors get to where they want to be if they stick to the plan. 
• Bear markets—however awful and disruptive they feel—can create substantial opportunities because they can create cheaper stocks with higher long-term return potential. 

Disciplined investors who appropriately deploy dry powder, or cash—via portfolio rebalancing—at the right time during a bear market can better maintain and protect their wealth. The rebalancing effect of dry powder can enhance long-term returns and allow for a more rapid recovery of a portfolio. Dry powder can come from any asset class that has a loss less than equities, additional cash flows held in reserve, new cash flows into a portfolio, and tax losses harvested and held in cash. 

In deciding when to invest dry powder, it is critical to understand that bear markets (stock values falling 20%) usually begin as the likelihood of recession rises, but before the economy actually contracts. Similarly, bear markets end during recessions—even as headlines cry about slumping economic growth and lost jobs. 

In today’s bear market, U.S. equities have already fallen roughly 20%, so it’s probably too late to sell. And Federal Reserve (Fed) policymakers don’t yet have enough spare capacity in the economy to shift from their hawkish stance of raising rates to quell inflation to a dovish stance in support of economic growth, so it is likely too early to buy. 

Going forward, the primary question for investors will be when might the Fed become more dovish? AMG believes that will happen at some point after core inflation is meaningfully closer to the Fed’s 2% target level. Until then, be patient and keep the powder dry.