“HAVE PATIENCE,” SAYS CHRIS HYZY, Chief Investment Officer for Merrill and Bank of America Private Bank. It may take another six to nine months for the markets and economy to “reset” after a period of historic challenges, including the highest inflation and the quickest interest rate increases by the Federal Reserve (the Fed) in 40 years.

 

“It’s possible that the economy will enter a recession later this year or in early 2024,” Hyzy says. It could be brief and mild if we see a sharp drop in inflation, he adds. “That might prompt the Fed to pause its rate increases and start focusing on both inflation and growth, instead of just inflation.” Other positive signals to watch for are a bottoming in the leading economic indicators, stabilization in corporate earnings and a weakening U.S. dollar, all of which could lead to a new bull market phase by mid to late 2023, Hyzy says.

Despite expected continuing volatility through the first six to nine months of the year, there are some steps you can consider now, Hyzy adds. “Stock valuations, while not cheap, have become more attractive, and rising rates have created new income opportunities.” A recent Portfolio Positioning report from the Chief Investment Office, “Considerations Through the Reset to the Next New Cycle,” details approaches tailored to different investing styles and priorities.  It all starts with your personal investing preferences and goals, Hyzy says. Explore the areas below that match your main investing focus. 

 

Fast track: Select your investing priority

• Balance and diversification
• Putting excess cash to work
• Retirement cash flow
• Long-term growth
• Conserving my assets
• Exploring alternative investments

 

I’m concentrated on balance and diversification

“Your portfolio should include investments across and within asset classes. When volatility is high, that’s essential,” Hyzy says. Consider large and small companies, growth (stocks that may outperform the market) and value (those that may be currently underpriced) and U.S. and international stocks. Bond investors should consider high-quality government, corporate and international bonds. Amid volatility, high-quality investments and defensive areas such as healthcare and utilities should be considered.

 

I want to put excess cash to work

People sometimes wait until markets surge before investing. Yet that can mean paying elevated prices, Hyzy notes. “The recent market weakness creates opportunities,” he adds. Downgraded corporate earnings estimates, inflation-related volatility, and negative sentiment over European stocks could offer various ways to enter markets at attractive prices in the next few months. This is not the same as market-timing — a high-risk activity that usually fails, Hyzy stresses. “It’s essential to invest in a disciplined manner.” Dollar-cost averaging (methodically purchasing assets at regular intervals) could help you enter markets in a disciplined way, he suggests. 

 

Generating cash flow for retirement is my top concern

There’s good news for those in or nearing retirement and looking for ways to boost investment income: “For the first time in more than a decade, U.S. Treasurys are providing income that’s higher than the expected rate of inflation,” Hyzy notes. And while falling bond prices (a result of rising rates) worry traders, income-focused investors who hold bonds to maturity receive the same interest and principal regardless of price fluctuations.

 

Consider Treasurys, Agency Mortgage-Backed Securities and investment-grade corporate bonds, Hyzy suggests. Keep in mind that bond income is taxed as ordinary income rather than at lower capital gains rates. If rising bond income creates tax concerns, options might include shifting some bonds to tax-advantaged accounts or investing in municipal bonds. Consult with your tax professional as well as your financial advisor, says Hyzy.

 

I’m focused on long-term growth

Volatility, which prompts short-term investors to divest from out-of-favor sectors, creates opportunities for those with a longer horizon. “Patient investors may find relative bargains in fundamentally solid companies poised to rebound when the reset period is over,” Hyzy says. Areas such as digitization and automation, climate change mitigation, clean energy and others may hold promise. Yet such investments could decline further amid short-term volatility, so it’s important to consider the risks and maintain a long-term perspective, Hyzy says.

 

My priority is conserving capital

Short-term bonds could lower your portfolio risks while generating some current income, says Hyzy. “Shorter-term yields are more attractive than they’ve been in a decade, providing solid cash flows while the Fed is bumping rates.” The trade-off: Short-term bonds typically offer lower yield than long-term bonds. A purely defensive portfolio may not provide capital appreciation or even keep pace with inflation and reinvesting for growth when the reset is over may be costly as asset prices rise.

 

I’m interested in exploring alternative investments

For qualified investors alternative investments (AI) such as hedge funds, private equity or real estate offer potential diversification, volatility control or enhanced returns. “These may perform relatively well because of their low correlations to traditional asset classes or because they tend to do well during times of high inflation,” Hyzy notes. For example, some real estate strategies benefit from the ability to charge higher rent. As with traditional asset classes, diversification is essential, Hyzy notes. And investors should keep in mind that AI investments tend to be less liquid than assets such as stocks or bonds.

 

Whether you fit neatly into one of the groups described above or your needs encompass several of them, it’s important to consider any portfolio changes in the context of your overall financial goals, Hyzy says. Ask your advisor what steps might best prepare you for the next several months and beyond.