Will the 2020s prove to be a great time for investors? To deliver on financial goals, it is said you only need to get three things right: adopt a tried and tested investment approach; prioritise risk management in all its forms; and contribute regularly, letting the probabilities and compounding carry you. This is true at any time in the cycle, but it is especially so today.
As we begin the roaring 20s, let’s consider how shares rallied in late 2019 to cement a strong year of gains across major equity markets around the world. Looking back over one of the stronger years on record, the common catalyst was the influence of central banks, whose support came in response to sluggish growth (both economically and in terms of corporate profitability).
Economic resilience
That said, counter to earlier signals, the global economy proved more resilient than many expected as the year wound to a close. Coupled with trade fears subsiding and greater clarity regarding a potential Brexit outcome (following Boris Johnson’s convincing victory in the UK election), this sent shares to record highs in many parts of the world.
All equity sectors gained ground, but energy was relatively weak as concerns around oil oversupply tempered gains and healthcare took some heat amid political developments. Booming technology stocks and the internet-oriented names in the communications services sector underpinned the ‘growth’ style’s outperformance of ‘value’ through 2019.
Turning to bonds, the US Federal Reserve’s policy reversal – which has given investors a renewed confidence in the ‘lower for longer’ interest rate outlook – drove strong returns across fixed income markets through 2019, although this did run out of steam as the year came to an end.
The broad message was clear, however, with central bank easing, low defaults and manageable inflation expectations helping bond investors. Even the riskier corners of the bond market did well, with high yield bonds and emerging market debt delivering double-digit gains.
New decade, old challenges
So, with the last decade delivering strong market performance, it seems investors need not worry – and yet, is this now about to change? Have the risks truly vanished? Even if they have, we would contend one major global investment risk has not vanished, but only worsened. That risk is overpriced markets.
Risk, we believe, is very much wrapped up with the price you pay for an asset so, as long as prices are elevated, investors should be mindful. That said, we still believe now is a great time for investors, if invested right, and for three principal reasons:
* Over 25-year periods, stocks have beaten inflation 100% of the time: That is not to say markets will beat inflation, just that the historical data – tested over more than a century in the US – validates that the general direction has been up.
And for good reason – investments are tied to businesses, so as long as the economy grows and businesses are well-run, investors can expect to generally benefit from the investments they own. Holding money in cash or under the mattress can prove useful but it is unlikely to be a sound long-term strategy as inflation will erode its value over time.
* Risk management allows a portfolio to be robust in a range of environments: Risk management is one of the most underrated elements of an investment process, especially when markets are at record highs. We expect the happiest hunting days to come after large market drawdowns, but you should still invest throughout, managing risk levels to reflect today’s realities. So, while some key markets look expensive, according to our research, investors can still achieve strong outcomes – especially on a risk-adjusted basis.
* Opportunities exist – but not in the normal areas: Our research shows many assets are priced to deliver lower returns in the next decade or so, regardless of whether global growth slows now or later. Major markets have become more overpriced recently, including US stocks and many bond markets. Generally, the future returns of most asset classes are unlikely to live up to those of the past decade, but some are much more attractive than others. We will be investing in a way that captures these opportunities and you should too.
Investors should build portfolios in a way that reflects their best research. One of the biggest parts of that research is that it pays to stay invested, putting the probabilities in your favour over the long term. To do that, we must closely examine risk, which is best defined as the potential for loss – as it maximises the opportunity for compounding gains. This allows a portfolio to withstand the harshest of environments and enjoy the sunniest of days.
Today’s opportunities cannot be described as the brightest ever, but we expect them to return considerably more than any mattress will over the long term. The message is clear – it is always a good time to invest, if you do it right.
Emma Morgan is a portfolio manager at Morningstar Investment Management
