Hi, Joab. Thanks so much for your question. It's a tricky one, haha.
First, it’s important to underline that stocks are risky by nature, regardless of the economic or geopolitical circumstances. When compared to other investments such as bonds and cash equivalents, stocks are much more volatile. They not only react to earnings reports, but are sensitive (in the short term) to geopolitical shocks and interest rate hikes or rate cuts.
Although it's perfectly normal to worry about the impact of war, right now the biggest concern on investors’ minds is interest rates, rather than the conflict with Ukraine. That’s because in a rising interest environment – such as the one we are experiencing now – both equities and bonds can get hit pretty hard. The stocks that suffer the most during high interest rate periods are small caps, emerging market stocks, and REITS (real estate). Everyone has a forecast about rates, but there's unfortunately no consensus on how fast or how much interest rates will rise in the US and abroad.
Now, turning to your question: We feel that within the stock universe, small caps are usually the riskiest of them all. They are followed by mid caps and growth stocks (e.g. tech, biotech, new energy, etc.). On the other hand, the safest stocks during prolonged periods of volatility tend to be defensive or high dividend-paying stocks. These are usually stocks from mature companies that tend to operate in industries such as consumer staples (e.g. snacks & alcohol), utilities (e.g. water & electricity), and basic medicines. If you think the war in Ukraine will send the global economy into a tailspin, then defensive stocks will tend to fare better than, say, a portfolio of small caps or tech companies.
But be careful if you're trying to time this. What makes it so difficult (and oftentimes ineffective) to invest this way is the TIMING of such economic cycles and the DEPTH of corrections. Don't forget that stock markets (especially in mature markets like the US) can be a lot more efficient than you think. You might get your directional view right, but the market might have already baked most of that information into share prices before you click “buy”. Then there’s the DEPTH aspect. You might time a correction correctly, but it might end-up being a short-lived correction. Within a few weeks (or even days), markets could be back to where they were before the crisis that scared you so much began. Such has been the case with COVID and with the Ukraine-Russia war. If you're not in the market at that time, you will have missed most of the upside.
This is why Next Pronto advocates for ALL investors to always be invested in the market with a passive, rather than an active or tactical approach.
This doesn't mean that your portfolio is condemned to experience all the market’s fury during a downturn. If your investments are in-line with your risk profile, your portfolio will have the right amount (and types!) of bonds, commodities, and cash. If it doesn’t, then you can consider how to solve that issue.
Short-term volatility is almost impossible to predict. There’s tons of new data feeding into the system every day – just look at the (unexpected) announcement of peace talks today. But if volatility is your main concern, instead of trying to time an economic cycle or a thematic (industry) cycle, you can reduce your exposure to small caps, and increase your share of defensive or high dividend-paying stocks.
We hope this helps.
All the best, Joab!
The Next Pronto Team
