It has been said that the markets can be a great teacher, even when the lessons learned are tough ones. As we enter the final stretch of an extremely difficult year for global markets, we share three lessons for global investors.
1. Diversification Doesn’t Always Work.
While high quality bonds are expected to be safe havens in times of equity market turmoil, that is not always the case and the traditional 60/40 equity to fixed income ratio isn’t always foolproof. The Morningstar US Core Bond Index was positive in 2000-2002, 2008 and early 2020 during equity market declines, but in 2022 the index is down 11.5% year-to-date. And a 60/40 portfolio as reflected by the Morningstar US Moderate Target Allocation Index is off 14% in 2022 as inflation and Fed tightening have taken their toll.
2. Timing the Market is Really Hard.
Equity market volatility has been extreme in 2022, making it difficult for investors looking to move in and out of the market. For example, the Morningstar US Market Index, representing the broad US equity market, has seen daily swings of 2% up or down on 33 trading days in the first nine months of 2022. This compares to only 7 days in the entire calendar year 2021 where the market saw such daily volatility.
3. Valuation Matters.
One potential bright spot of 2022 is a reset in equity valuations. While the US equity market was overvalued coming into 2022 by Morningstar estimates, 2022 has seen a decline in valuations for some of the most richly valued pockets of the market. Traditional growth names like Microsoft, Amazon, Alphabet and Nvidia have all taken it on the chin, down more than 20% year-to-date. In this environment, new opportunities have emerged in areas like value-oriented stocks, energy, utilities, consumer defensive and dividend payers. The Morningstar Wide Moat Focus Index, which screens for high-quality stocks trading at attractive valuations, is a good place to find some of these relatively undervalued stocks like Gilead Sciences, Polaris and Tyler Technologies.
Dan Lefkovitz – Index Strategist, Morningstar
“The highest fliers of recent years have fallen furthest in the equity market downturn of 2022. Value stocks, dividend payers, and the energy sector have all held up relatively well. The good news about the pullback in 2022 is that the aggregate market looks more reasonably valued than at the start of the year and investors now have an opportunity to buy great companies at good prices and find value in different areas of the market. And, with bond yields much higher than at the start of the year, fixed income has become more attractive.”
To speak with Dan Lefkovitz, reach out to Tim Benedict at tim.benedict@morningstar.com or (203) 339-1912.
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