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Investing in Unpredictable Markets

The recent market rally inspired several calls from clients asking whether it is time to invest money again, after a bruising first half of the year. With the past week seeing stocks retreat off their recent highs, it is a good time to review how one should invest in unpredictable markets.

The S&P reached its lows for the year on June 16th, down 23% from January 1st. Over the next nine weeks, ending August 19th, the S&P had climbed 15% off its mid-June close, the Nasdaq had rallied 20% and the Dow was up 14%. If the markets continued their climb, basically uninterrupted, one would call this a V shaped recovery, where markets pick themselves up and don’t look back. During significant rallies, some investors experience FOMO (fear of missing out). The last V shaped rally we had was in 2020, during the pandemic, when the S&P 500 dropped 31% during the first three months of the year and ended the year up 18.40% — a 49.4% move.

More frequently, however, markets rebound from deep downturns in fits and starts. One term for intermittent bounces off lows is “bear market rally;” another is “dead cat bounce” – meaning stocks rise in the interim but then continue their downward trajectory, leaving investors who jump in on the upside facing unexpected losses.

Will we soon experience the beginning of a V shaped market recovery, where markets can overlook negative news and focus on a more positive future? Or will we be subject to repeated whiplash as markets get ahead of themselves and then retreat?

Unfortunately, we don’t know yet, although we are inclined to believe there is more volatility to come. Since my last blog, which discussed the relationship between inflation and recession, data is mixed. Inflation has probably peaked following the pullback in commodity prices but could remain sticky. A hawkish Federal Reserve has signaled that it will continue the current plan of raising interest rates and holding rates high until inflation is under control, leading to the oft quoted prediction that a recession is coming. The labor market is still overheating, whereby those who want a job can have a job, and wages are rising. At the same time Q2 corporate profits have handily beaten expectations and supply chains are healing. However, we are seeing signs of a weakening housing market accompanied by stubbornly high rents, and the rest of the world is threatening to go into its own recession. So, no clear messaging from the economy.

Restoring price stability is key to sustained, improving US economic data. That has not happened yet. It will take time for the Federal Reserve to get the process right and inflation under control, and that means more uncertainty.

So, if you have cash on the sidelines that you want to invest, what are you supposed to do? If you are a very conservative investor, you can wait it out, enjoying modestly higher interest rates in high yield money market accounts, until you feel risk is comfortably less. And if you are younger and/or more aggressive in your risk taking, you can put your waiting cash into the markets, with the understanding that potentially poor timing now is unlikely to derail your long-term plans.

But if you are neither very conservative nor very aggressive, it can be hard to determine how to invest and when. In periods of high market volatility, like we are seeing now, the best approach may be to dollar cost average in– put your money to work in equal increments over a fixed period of time.

Dollar cost averaging (DCA) isn’t new. 401(k) investors practice this approach all the time with their monthly withholding from pay checks. In reverse, retirees who take their RMDs monthly are also practicing a form of dollar cost averaging.

For most of the last dozen years market prices have increased, favoring lump sum investing, where shares are purchased at the lower end of rising prices.  Dollar cost averaging generally performs better in declining markets when shares are purchased over time at lower and lower values.  In the current unsettled economic and market environments, investors may perceive greater immediate risk than in recent years and want to hedge that risk by investing methodically over time.

One caveat:  dollar cost averaging does require follow-through and self-discipline to achieve its benefits. As markets tumble, it can be emotionally difficult to regularly add money to your accounts. That, of course, defeats the purpose of dollar cost averaging, which is designed to be a dispassionate process that helps to control emotional responses to market volatility.

In sum: during the first half of the year market performance was lousy. The second half of the year is giving us mixed results, with no end in sight for uncertainty. That means that it is unclear which market rally will stick and how soon that could happen.

If you have money that you want to employ but are afraid of missing the upside and/or getting caught on the downside, then consider periodic investing. Whether you decide to divide your investments into two, four or more payments and invest monthly or quarterly until a defined date, you can tailor your strategy to match your risk tolerance and confidence of execution.

 

Betsey A. Purinton, CFP® is Managing Partner and Co-Chief Investment Officer at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at bpurinton@strategicpoint.com.

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