By Michael Fredericks
Investors returning to their desks after peaceful holiday breaks were probably jolted at their desks by the rout in both stock and bond markets.
Federal Reserve officials signaled an even faster timeline for interest-rate hikes, causing the 10-Year Treasury yield to bolt higher and equities–particularly techy, more speculative names–to get battered.
For investors, 2022 may at first glance look murky. Powerful forces that pushed equities to all-time highs now seem to be on the cusp of fading. For older generations (or faux hipsters in the current one), this may recall the jarring sound a record player makes when the needle abruptly stops on a favorite track.
So, what should income investors do in this world that’s poised to undergo a regime shift? They need to develop a complicated relationship with the quality of their assets. Basically, in stock markets, embrace quality. In bonds, be more willing to ditch it, selectively.
We also believe that we are likely entering a period when no single trade or asset will dominate, which means that investors can benefit from spreading their chips across different markets. Will 2022 see a fourth straight year of double-digit returns in global equities? Perhaps. But will a handful of tech titans account for a third of the gains of the S&P 500 Index again? I’m very doubtful.
Just in January, we’ve witnessed the fragility of having such a narrow focus on growth. In the first week of 2022, about 40% of stocks trading on the Nasdaq were down 50% or more from their one-year highs.¹ And the Fed’s actions in 2022 may further dent the appetite for high-valuation, speculative companies.
This is why our team is seeking to invest in areas of the equity market that have been left behind. In fact, a bout of volatility may be an opportunity to scoop up dividend stocks that have consistently demonstrated wider profit margins and reliable revenue streams – features that can also help them overcome inflation pressures.
When it comes to the bond market, our portfolios have minimal exposure to government fixed-income and investment-grade credit. The picture for high yield is a little trickier. As we get later in the economic cycle, the extra compensation bond investors are getting for going down in quality is increasingly thin. Our team has been focused on selecting the high-yield bonds of companies that we believe will prove resilient during the next economic crisis or recession.
We’ve also been incrementally adding to loans over bonds, demonstrating our preference for being higher up in the capital structure for the same company. Bank loans may also offer resilience against rising interest rates as their coupon payments adjust relative to short-term rates.
All in all, it seems to me as a fresh year kicks off, that investor conviction is low. As mentioned, it’s likely tied to expectations for higher rates and less liquidity this year. Many investors believe the prolonged period of ultra-easy global monetary policies that’s been with us could be winding up.
The downbeat mood in markets is also probably tied to being tired of trying to forecast the path of the ongoing pandemic. Against this backdrop, my team believes that the first line of defense in 2022 will be discipline and selectivity. It doesn’t have to be the end of your favorite song. We just need to reset the vinyl for the next track.
1 Source: Bloomberg, January 10, 2022.
This post originally appeared on the iShares Market Insights.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.