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Three Considerations for Investors Facing Economic Uncertainty

Darrell Cronk, President of Wells Fargo Investment Institute, shares his thoughts on the current environment for investors and how to help manage portfolio risk in 2020.

A man standing on a mountain peak looks at the sun peeking through the clouds.

In late 2019, trade disputes, geopolitical concerns, and slowing global economic growth were stoking market volatility—and leaving many investors wondering what’s next. These concerns along with the unexpected outbreak of novel coronavirus (COVID-19) and oil price shock set grounds for near-record-high stock market volatility and sent the U.S. stock market into bear territory in March 2020. According to Darrell Cronk, President of Wells Fargo Investment Institute, although the aggregate economic impact of the coronavirus cannot be fully quantified at this time, he asserts that it is likely that the U.S. economy will enter into a short, and possibly deep recession in 2020.

According to Cronk, who also serves as Chief Investment Officer of Wealth and Investment Management at Wells Fargo: “We expect the virus outbreak to weigh heavily on economic uncertainty over at least the next three to six months. There has historically been pent-up demand following periods of contracting growth. That, coupled with the lagged impact of sizable monetary stimulus and the potential for more fiscal stimulus, creates the potential for a rebound later this year, in our view,” says Cronk.

In December 2019, Cronk reminded investors that “We are going to have another recession. I can’t tell you when, just as I can’t tell you when it will rain. But it will rain, and the time to carry an umbrella is now.” His reminder was timely. In March 2020, fears about coronavirus, oil prices, and the prospect of a global economic slowdown drove the U.S. equity market into bear market territory.

Cronk offers guidance for long-term investors to ride out the storm and position portfolios to meet long-term investment goals.

1. Remain committed to diversifying and rebalancing

Cronk reminds investors that diversification is key to preparing for a potential downturn. He advises investors to consider increasing their exposure to hedge funds and private capital1 if they qualify. Among his reminders: Be strategic with cash, using it selectively during market pullbacks. Know what you’re invested in, because sentiment can overcome true value toward the end of economic cycles. Keep an eye on asset allocation, and consider rebalancing—moving some dollars from the highest-performing investments to those that may not have seen as much growth. Cronk also reminds investors that timing the markets can be very costly. In fact, WFII has found that missing the 10 best days in the S&P 500 Index equity market over the past 30 years, significantly reduced total returns for the index, and many of those best days came during the heart of bear markets. (Source: Wells Fargo Investment Institute First Quarter 2020 Market Charts, which includes data from fourth quarter 2019. See slides 32 and 99.)

2. Focus on quality

When it comes to investing in an uncertain environment, we believe that quality matters at the asset-class and sector levels. For quality, we focus on U.S.-based large-cap companies with sizable cash positions, strong balance sheets, and growing dividends.

3. Look at long-term diversification, as shorter periods are likely to be volatile

For the near term, Cronk is focused on watching three main signals:

  1. A peak in the COVID-19 infection rate: While China and South Korea case growth has slowed, we are still early in case evolution across Europe and North America. Just like in markets, a peak will be hard to call, but look for a deceleration signaling containment.
  2. A slowing in market re-positioning: Early 2020 investor positioning coming off really strong 2019 market performance had investors caught flat-footed when the COVID-19 shock initially hit. Fear of uncertainty often proves a stronger emotion than what reality eventually delivers.
  3. A return of significant risk premium levels: Equity risk premiums are beginning to push into attractive areas at slightly above one standard deviation from normal historical levels. Historically, since 1962, when these levels were reached, the S&P 500 Index on average produced double-digit returns over the next 12 months. Watch for a spike in risk premiums that could generate a rotation by investors out of overbought fixed income into oversold equities.

As painful as market downturns can be, they are a normal part of investing and can create long term opportunities. Stock market bottoming involves a process. Long-term investors may reduce short-term volatility risk by using cash tactically, focusing on high-quality assets, and positioning into more defensive asset classes and sectors. Cronk reminds investors that historically, one of the best long-run approaches has been to diversify across a combination of low-correlated assets and regularly rebalance back to strategic targets.

 

1. Alternative investments, such as hedge funds, private equity and private real estate funds are not suitable for all investors and are only open to “accredited” or “qualified” investors within the meaning of U.S. securities laws.

Mike Woelflein is a business and investment writer based in Yarmouth, Maine.

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Wells Fargo Investment Institute, Inc. is a registered investment adviser and wholly-owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this article was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this article and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this article. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this article.

The information contained herein constitutes general information and is not directed to, designed for, or individually tailored to, any particular investor or potential investor. This report is not intended to be a client-specific suitability analysis or recommendation, an offer to participate in any investment, or a recommendation to buy, hold or sell securities. Do not use this report as the sole basis for investment decisions. Do not select an asset class or investment product based on performance alone. Consider all relevant information, including your existing portfolio, investment objectives, risk tolerance, liquidity needs and investment time horizon.

Forecasts and targets are based on certain assumptions and on views of market and economic conditions which are subject to change.

Past performance is not indicative of future results, and there is no assurance that any investment strategy will be successful. All investing involves risk, including the possible loss of principal.

Asset allocation and diversification are investment methods used to help manage risk. They do not guarantee investment returns or eliminate risk of loss including in a declining market.

All investing involves risks including the possible loss of principal.  Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers.  Investments in equity securities are generally more volatile than other types of securities.

Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.

Alternative investments carry specific investor qualifications which can include high income and net-worth requirements as well as relatively high investment minimums. They are complex investment vehicles which generally have high costs and substantial risks. The high expenses often associated with these investments must be offset by trading profits and other income. They tend to be more volatile than other types of investments and present an increased risk of investment loss. There may also be a lack of transparency as to the underlying assets. Other risks may apply as well, depending on the specific investment product. Alternative investments, such as hedge funds and private capital/private debt strategies, are not suitable for all investors. Any offer to purchase or sell a specific alternative investment product will be made by the product’s official offering documents. Investors could lose all or a substantial amount investing in these products. Some alternative strategies may expose investors to risks such as short selling, leverage risk, counterparty risk, liquidity risk and commodity price volatility risk. In addition, alternative strategies engage in derivative transactions. Short selling involves the risk of potentially unlimited increase in the market value of the security sold short, which could result in potentially unlimited loss for the fund. In addition, taking short positions in securities is a form of leverage which may cause a portfolio to be more volatile. Derivatives generally have implied leverage and may entail other risks such as liquidity and interest rate and credit risks. Successful hedging strategies may require the anticipation of future movements in securities prices, interest rates and other economic factors. No assurance can be given that such judgments will be correct.

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