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Investment Outlook: Preparing for an Uncertain Second Half

Uncertainty around the coronavirus outbreak and the upcoming U.S. elections could continue to impact the markets. Here, a Wells Fargo Investment Institute strategist shares his thoughts on how to prepare.

A man stands near rock formations.

As we near the halfway point of 2020, the investment outlook for the rest of the year remains uncertain with many unanswered questions. To what extent will the coronavirus pandemic impact the U.S. economy, domestic and global markets, and American society? And in the 2020 U.S. election cycle, who will win the presidency and which party will control the House and the Senate?

Despite the market’s pullback and all of the ongoing uncertainty, investors should remain diligent and resilient, according to Paul Christopher, CFA, Head of Global Market Strategy at Wells Fargo Investment Institute (WFII). “We believe successful investing strategy is about balancing risk and potential reward,” he says. “During highly uncertain times – such as these – we think it’s especially important to manage risk, and we can be specific about what that means to us.”

Here, Christopher shares key considerations for investors during these uncertain times.

Seek out quality stocks

WFII’s recommendations have skewed more cautious since recommending a conservative approach to equities and fixed income in 2019. The market’s sharp pullback in March confirmed the wisdom of focusing on quality—meaning stocks, bonds, and other assets that may be unlikely to decline as much compared to the rest of the market in a downturn, Christopher says. He says although virtually everything declined, quality assets proved more resilient.

“We’re still all about quality,” he adds. That means stocks backed by strong earnings growth, a strong balance sheet (meaning good cash flow and attractive cash-to-debt positions), and an excellent management team. Within bonds, quality tends to imply investment-grade, deemed less susceptible to default because they are backed by strong revenues, earnings, and credit payment history—and solid capital. “During sustained periods of market weakness, quality assets should outperform (as they did during February – April),” says Christopher. “Sometimes, markets may even rally temporarily before resuming their decline. That’s when it may pay to sell non-quality assets and set aside cash to reinvest in preferred asset classes and sectors. We believe it’s more about following your plan, staying disciplined, and making sure you’re managing risk wisely.”

Consider a deliberate and incremental strategy

Many high-net-worth investors may have much more cash set aside than could be necessary, Christopher says. (Learn more about how much cash you should have on hand now.)  “This could be a good opportunity to start thinking about building out a diversified portfolio for this new situation,” he says. “We’re suggesting a deliberate and incremental plan, adding exposure where risk is compensated by potential reward, especially over the long term.”

WFII recently downgraded emerging-market equities because quarantines, containment measures, and weak prices for emerging-market commodity exports kept consumers from spending and slowed business activity. After the long bull market, WFII upgraded U.S. mid-cap stocks, which may tend to offer similar or even better dividend yields but are more domestic and less exposed to the headwinds of a global slowdown or a strengthening dollar. Within fixed income, WFII recommends consideration of high-quality, longer-duration U.S. corporate bonds, residential mortgage-backed securities, and preferred securities.

Explore diversification options

If you’re an accredited investor, you likely have more diversification opportunities than the general public does, Christopher says. “We believe the recovery from this will be strong, though when that happens is hard to predict,” he says. As a result, Christopher says it could be a good time to consider the following:

  • Private capital. Buying a stake of a business or loaning money to a company has historically been a way to withstand short-term volatility and profit over the long term. “We believe there’s value out there now,” Christopher says.
  • Hedge funds and other alternative vehicles. Hedging strategies, which allow investors to potentially profit from losses from stocks and other investment vehicles, are designed to potentially perform well in down markets. Christopher recommends considering hedge funds and other alternative investments that can go long (buying a stock to sell at a profit) or short (borrowing shares and selling them, hoping to profit from buying them back at a lower price). “We’ve been reminded that hedging can help offset volatility,” he says.
  • Option investing. Options let investors buy or sell securities at a predetermined price over a certain period of time. After the sharp market decline, the limited downside participation of puts, which benefit from an asset’s falling price, got very expensive. On the other hand, demand for calls (options that pay off when the underlying vehicle advances) dropped, making them cheaper. “High-net-worth investors might want to consider buying calls as an upside opportunity, to give themselves the option to buy once they see a bottom,” Christopher says.

Stick to your long-term strategy

In the past century or so, major U.S. elections have generally been good for investors. The S&P 500 has advanced in 19 of the 23 presidential election years since 1928, and three of the four declining years occurred during recessions. This year’s sudden and deep recession presents a challenge to President Trump’s re-election bid, and the lockdowns across the country test former Vice President Biden’s ability to raise funds and reach voters.

Whatever the outcomes of the elections, they could dramatically affect key geopolitical issues that influence markets, such as trade agreements, taxes, health care laws, and monetary policies. “There may be a temptation to speculate, based on the latest news or polls,” Christopher says. Widely differing trajectories for the coronavirus infection rates and the as-yet untested effects of ending the lockdowns affect everything from polls to fundraising to likely voters in November. “In our view, long-term investors who want to look beyond the crisis through to the recovery should stick close to their long-term strategy and allocations. Investors who want to adjust to current opportunities should emphasize quality.”

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.

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.

Stocks offer long-term growth potential, but may fluctuate more and provide less current income than other investments. 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. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Mid-cap stocks are generally more volatile, subject to greater risks, and are less liquid than large company stocks. 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. Preferred securities have special risks associated with investing. Preferred securities are subject to interest rate and credit risks. Preferred securities are generally subordinated to bonds or other debt instruments in an issuer’s capital structure, subjecting them to a greater risk of non-payment than more senior securities. In addition, the issue may be callable which may negatively impact the return of the security. There is no guarantee that dividend-paying stocks will return more than the overall stock market. Dividends are not guaranteed and are subject to change or elimination. In addition to the risks associated with investment in debt securities, an investment in mortgage-backed securities will be subject to prepayment, extension and call risks. Changes in prepayments may significantly affect yield, average life and expected maturity. Extension risk is the risk that rising interest rates will slow the rate at which mortgages are prepaid. Call risk is the risk that If called prior to maturity, similar yielding investments may not be available for the Fund to purchase. These risks may be heightened for longer maturity and duration securities.

Alternative investments, such as hedge funds, private capital/private debt funds, and private real estate funds, are not suitable for all investors and are only open to “accredited” or “qualified” investors within the meaning of the U.S. securities laws. They are speculative, highly illiquid, and are designed for long-term investment and not as trading vehicles. There is no assurance that any investment strategy pursued by the Master Fund (and thus the Feeder Fund) will be successful or that the fund will achieve its intended objective. Investments in these funds entail significant risks, volatility and capital loss including the loss of the entire amount invested. They are intended for qualified, financially sophisticated investors who can bear the risks associated with these investments. Investors should read the fund’s offering documents prior to investing.

Purchasing and writing options are highly specialized activities and entail greater than ordinary investment risks. The successful use of options depends in part on the ability of the Investment Adviser to manage future price fluctuations and the degree of correlation between the options and securities markets.

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