The Need for Investors to Take Less Risk in the Market

Marc Zabicki:

Forecasting equity in bond markets and managing investment portfolios has never been easy, but the job probably has gotten a bit more difficult over the last five or ten years. Why is that? Well, in this latest edition of LPL Street View, we will take a look at some persistent issues facing investors and one currently prevailing event that we believe should have investors contemplating the level of risk they take in their portfolios. Yes, we believe investors should indeed be taking less risk in their portfolios today than they have in previous years. Why? Because one visibility is muddied and returns are more volatile, then the right thing to do is to simply take less risk. Global confrontation is a well-known variable in equity in bond markets of the present and of the past, and there is often not a lasting impact when tensions rise. However, survey data from the Bank of England shows that since 2014, geopolitical risk has become increasingly prevalent.

Marc Zabicki:

If we add to that the element of political risk and the often wide swings in policies that come with a volatile political environment, we can see how the investment landscape can be increasingly hard to navigate as political risk rises and policy visibility wanes, which has been the trend since the great financial crisis, investors should account for this variable by taking less risk in their portfolio than they otherwise would. Have you noticed how the market seems to be prone to wide swings in pricing and momentum often pushes the market out of equilibrium quite often? We certainly have indeed noticed the existence of high-frequency trading and the fact that much of this market's volume is driven by algorithm has exacerbated this effect. These algorithms can change the market in seconds, and most investors are not equipped to adjust that quickly. What do you do to offset this increased price volatility and the lack of visibility into potential directional changes in price?

Marc Zabicki:

You take less risk in your portfolio. Finally, we note that the market right now is increasingly being driven by a handful of stocks. While this dynamic has pushed equity benchmarks higher, it adds an element of risk to the market environment. This chart shows the variance between the S&P 500 index and its equal-weighted counterpart. Notice the variance between the two indices has been notably prevalent in the post-covid era. This means that fewer stocks have been driving index prices higher. Our concern is that the lack of breadth in this market could potentially add to price volatility should one of the leading stocks hit an air pocket. Again, investors should tightly manage their risk in this heavily concentrated market. These are just some points to keep in mind as you align your investment strategy to meet your goals. The message here set aside the impulse to chase returns. Remember, wealth building does not require that you beat the S&P 500 index at every turn. On the contrary, oftentimes slow and steady wins the race. Thanks for listening, and as always, allocate wisely.