Nothing creates market opportunities quite like volatility. And so far in 2022, we’ve seen plenty of it. The good news? For those with cash to allocate, several investment strategies look particularly attractive right now.
What’s more, there’s more than one way to participate. These strategies vary in terms of complexity, level of risk, and degree of concentration, but each appears compelling given the economic and market landscape investors face today.
Turning Lemons into Lemonade
Perhaps the simplest strategy to benefit from the current backdrop is taking advantage of losses in some stocks to offset gains in others. Consider that the market’s recent retracement has left many wondering whether we’ll retest June’s lows. While no one can say for sure, investors will be prepared either way with this tax-savvy approach.
If the market falls further from here, they can harvest tax losses in their portfolio to offset capital gains elsewhere and improve after-tax returns. On the other hand, if the market rallies sharply, investors can ride that wave and enjoy those gains. Plus, with the market having fallen this year, the cost of transitioning from a standard equity portfolio to a tax loss harvesting strategy is relatively low, since the market’s decline has reduced the embedded capital gains investors may have in existing stock portfolios.
Protecting and Participating Twice Over
Another potential opening—especially for those with cash on the sidelines—comes from combining defined outcome ETFs and high-yield bonds (municipal or corporate debt, depending on your tax status).
According to Bloomberg, assets in so-called “buffered” ETFs have swelled to about $13.6 billion since their debut nearly four years ago and they’ve experienced strong inflows of late.i Yet, many investors are still not familiar with them. By using a set of stock options, defined outcome ETFs enable investors to earn the market return up to a certain upside level (the “cap”). In exchange for giving up returns past that point, investors avoid the first 15%ii of any stock market decline. Essentially, these vehicles are designed to facilitate participation in a rising market while outperforming in a falling one. You can see how they’ve protected against downside during past sell-offs in the Display below.
Combining buffered ETFs with high-yield bond strategies introduces income while investors wait. With Treasury rates on the rise along with the price of credit, investors stand to earn high-single-digit yields from high-yield bonds over the next several years. While these bonds could fall in price temporarily should a recession materialize, historically their starting yields have been meaningful indicators of future returns.
Growth on Sale
Given the degree of turbulence in the equity markets so far this year, many stocks appear to have been thrown out with the bathwater. We’ve also seen a massive rotation favoring value stocks over their growth peers, producing attractive opportunities in growth companies. In many cases, these stocks have fallen more than the market, even as analysts have increased their earnings estimates for these former darlings.
Looking at pockets of potential, two distinct flavors emerge: high-quality, high-growth names and companies with longer and faster growth runways based on disruptive technologies. Both have sold off substantially this year. Some investors may find safer and currently profitable companies more compelling; others may be attracted to companies with fast and idiosyncratic growth trajectories which have been among the market’s most beaten-up names of late.
Who Said Banks Are Boring?
Finally, we continue to believe in the long-term consolidation of the US banking system. There are still over 4,000 banks in the United States. All of them are poised to benefit from looser banking regulations, tax cuts, and higher interest rates—fuel for higher profitability and earnings growth. But even more interesting, many of the smaller banks are attractive acquisition targets for larger players. A consolidation trend, driven by the need to better absorb fixed costs (particularly with technology budgets becoming more critical), has fostered a long-term tailwind for takeovers. For investors in the space, this can mean outsized return potential, especially as medium and large banks become more profitable and acquisitive in today’s rising interest-rate environment.
The Choice Is Yours
A long-term, strategic asset allocation is key to achieving your financial goals over decades. Yet complementing it from time to time with opportunistic exposure can enhance your overall returns, on both an absolute and risk-adjusted basis. Depending on your circumstances, one or more of these ideas may make an attractive addition to your current portfolio no matter the market’s near-term direction.
- Matthew D. Palazzolo
- Senior National Director, Investment Insights—Investment Strategy Group
- Christopher Brigham
- Senior Research Analyst—Investment Strategy Group
ii Percentages vary depending on how much upside investors are willing to forgo.