Insights

Portfolio Construction
5 Keys to investing in 2020
Joyce Gordon
Equity Portfolio Manager
Darrell Spence
Economist
Mike Gitlin
Head of Fixed Income

With the beginning of a new year, investors often take some time to assess their portfolios and establish expectations for the road ahead. If any lesson can be drawn from 2019 — with its sudden shifts in the U.S.-China trade war, the U.K.’s Brexit drama and global monetary policy — it’s that investors should expect the unexpected.


Time will tell what surprises will greet investors in 2020, a presidential election year in the U.S. But despite political and economic uncertainty, some steps can help insulate investments from the inevitable twists and turns that will surely drive market volatility. Here are five keys to staying on track in the year ahead.


1. Patient investors can do well in election years


As in any presidential election year, politics are sure to dominate news headlines in 2020. And with impeachment proceedings looming over Washington and debate raging over health care policy, this election cycle is shaping up to be especially contentious.


Investors may have strong preferences for one candidate or political party when it comes to the direction of the country. But history suggests that the election outcome will make little difference when it comes to the direction of markets. A look back at the presidential election cycles since 1932 shows that U.S. markets have consistently trended upward after presidential elections, rewarding patient investors — regardless of who occupies the White House.


“Presidents get far too much credit, and far too much blame, for the health of the U.S. economy and the state of the financial markets,” says Capital Group economist Darrell Spence. “There are many other variables that determine economic growth and market returns and, frankly, presidents have very little influence over them.”


To be sure, investors can expect heightened market volatility this election year, especially during the noisy primary season. But election-related volatility can produce select opportunities. For example, pharmaceutical and managed-care stocks have recently come under pressure amid political criticism of private-sector health insurance. That, in turn, has resulted in some attractive company valuations for investors who believe that a government takeover of the American health care system isn’t imminent.


“Investing during an election year can be tough on your nerves,” explains Greg Johnson, a Capital Group portfolio manager, “but it’s mostly noise and the markets carry on. Long-term equity returns are determined by the underlying fundamentals of individual companies.”


The bottom line: It may be better to stay invested than sit on the sidelines.


2. The best offense may be a good defense


Election-related news won’t be the only concern weighing on investors in 2020. With the U.S. economy in late-cycle territory and the direction of U.S.-China trade relations not yet resolved, investors may be worried that a downturn is on the horizon. While a recession in not likely in 2020, it’s never too soon to prepare ahead of rough seas.


To do this, many investors may instinctively want their portfolio to take a more defensive approach, shifting toward so-called value-oriented investments. But the value label can be misleading: Not all value-oriented investments have acted defensively during recent periods of stock market volatility.


Instead, investors may want their portfolio to focus on dividend-paying companies, which have historically played an important role in helping to mitigate equity market volatility. However, not all dividend payers are equal or even sustainable, so selectivity is essential.


Between September 20, 2018, and November 30, 2019, a period of trade-related volatility, companies with above-average credit ratings outpaced those with lower ratings. What’s more, dividend payers with above-average credit ratings outpaced both companies with lower credit ratings and those that paid little or no dividends.


“I steer clear of companies that have taken on too much debt,” notes Joyce Gordon, a Capital Group portfolio manager. “Companies at the lower end of the investment-grade spectrum can struggle to fund themselves in a recession, increasing the risk that they might cut their dividends.”


Companies with solid credit ratings that have paid meaningful dividends can be found across a range of sectors. Some examples include UnitedHealth, Microsoft, Procter & Gamble and Home Depot.


3. If you think all the best stocks are in the U.S., think again


While international equities rose in 2019, they lagged the S&P 500 Index — the eighth such time in the past decade. This remarkable dominance by the U.S., driven by innovative tech and health care companies, has raised questions about whether it still makes sense to maintain exposure to international stock markets.


In fact, it makes more sense than ever if you consider how dramatically the world has changed under the influence of free trade, global supply chains and the rapid growth of multinational corporations. “Where a company gets its mail is not a good proxy anymore for where it does business,” explains Rob Lovelace, a Capital Group portfolio manager, which invests in companies all over the world. “The debate over U.S. versus non-U.S. stocks made sense at one time. But the world has changed, and investors need to change their mindset as well.”


Even during this past decade of U.S. dominance, most of the best stocks have been found outside the United States. Over the past 10 years, non-U.S. companies usually dominated each year’s list of top 50 stocks, even though the U.S. index did better overall. In 2019, 37 of the top 50 stocks were based on foreign soil.


It’s about selecting companies, not indexes. In a year when political pressure has weighed on many U.S. health care companies, Japanese pharmaceutical giant Daiichi Sankyo was one of the top returning stocks. Likewise, Kweichow Moutai, far from a household name outside of China, became the world’s largest spirits company by market value after its stock nearly doubled in 2019.


4. Fixed income should do more than reach for yield


In 2019, the bond market repeatedly sent signals that risks with the potential to derail the global economy are mounting. Central banks around the world have aggressively slashed interest rates in an effort to counter the effects of slowing growth and a painful trade war. Among developed markets, the U.S. has become the exception in a world where negative rates are the strange new normal. And in the U.S. an inverted yield curve warned that a recession could be near.


And in addition, asset prices appear elevated across equity and fixed-income markets — meaning it may be time to evaluate whether bond portfolios are positioned to fill all the roles of fixed income. Given the late-cycle U.S. economy and weakness abroad, core bonds that can help mitigate stock market volatility may be a wise choice for fixed-income allocations.


“The best way to balance a portfolio in uncertain times is to build a strong core bond allocation,” says Mike Gitlin, head of fixed income at Capital Group. “What does that mean? It means holding bonds that will provide not only income, but the other roles of fixed income as well: diversification from equities, capital preservation and inflation protection. That way, no matter what the market environment, fixed income should help portfolio resilience through the balance it can provide.”


Consider what happened during the six equity correction periods, in which stocks declined 10% or more, since 2010. In each of these periods, core persevered.


5. Don’t let uncertainty derail your long-term investment plan


Sudden and steep market declines can unnerve even the most experienced investors. That is understandable. Worried investors inevitably will be tempted to take action to avoid pain. But while it is not easy, the best course is to keep calm and carry on.


This impulse isn’t confined to periods when stock prices are falling — it’s equally tempting when stocks are rising. Just as some investors are inclined to reduce equity exposure following a market decline, others are reluctant to maintain stock investments during a rising market because they worry that a correction might occur.


But maintaining a well-balanced portfolio may be the best approach in any market environment. Consider that since 1999 the largest intra-year declines in the S&P 500 have averaged 15%, but the index has ended in positive territory in 15 out of the last 20 calendar years. As a result, a hypothetical initial investment of $10,000 in the stock market, as represented by the S&P 500, would have grown to an ending value of more than $31,000 as of November 30, 2019.


Although volatility can be unnerving, it also can represent further investment opportunity for patient, long-term investors.


 

Posted January 6, 2020



Joyce Gordon is an equity portfolio manager at Capital Group with 39 years of investment experience. She holds an MBA and a bachelor’s in business finance from the University of Southern California. 

Darrell Spence is an economist and research director with 27 years of investment experience, all with Capital. He earned a bachelor's degree in economics from Occidental College and is a CFA charterholder.

Mike Gitlin is head of fixed income at Capital Group. He has 25 years of investment industry experience. Before joining Capital in 2015, Mike was head of fixed income and global head of trading for T. Rowe Price. He holds a bachelor's from Colgate University.


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