December 08, 2022
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2022 has been a tough year for equities. High inflation and increasing interest rates are expected to bring a recession next year. Our outlook for equities is that volatility will continue for much of the new year. This can lead some to ask if they should favour safer assets. We think the answer is no and explain through a series of four charts that provide perspective on why maintaining your long-term allocation is so important.
1. Equities rise over time
When there are formidable risks ahead, it can be uncomfortable to stick with equities. Yet when removing oneself from the current environment and looking at a longer period, one can see the benefit of stocks. Despite bouts of volatility, the trend is clear. Stocks rise much more frequently than they decline.
Participation
in markets, especially in times of uncertainty has served investors well
2. Stocks are still the best way to grow capital
For long-term investors, equities outperform bonds and cash by 4-6% per annum. In the charts below we show relative stock performance over rolling 10-year periods. Outside of the periods surrounding the global financial crisis of 2008-2009, equities have outperformed most of the time.
Stocks, bonds and cash returns are defined as the S&P 500,
Bloomberg Aggregate Bond Index and the US 91-day Tbill Index, respectively. All returns
are annualized and in USD. Source: Connor, Clark & Lunn Private Capital Ltd.
3. Equities protect against long-term effects of inflation
The current landscape is one of high inflation which has led to rising interest rates. This has produced negative returns in the short term for stocks and bonds. Cash returns are higher but still well below inflation levels. From a long-term perspective, equities offer the greatest protection from inflation. This is both in terms of the amount they have outperformed inflation and their frequency. While bonds have outperformed inflation in many periods, they have done so by a much smaller margin. To combat high levels of inflation portfolios need an allocation to equities.
Asset class performance in excess
of inflation
4. Stock recoveries are sharp
Significant stock market declines are always unsettling. They occur during periods where uncertainty is high. The silver lining of these declines is that they are temporary. We don’t need all the risks today to be resolved for markets to begin a recovery. Recoveries start long before investing feels safe again and the rebound in prices is swift. The last two recoveries from bear markets are good examples. In the first six months, stocks returned 55% and 46%, respectively. Of course, the start of the recovery is only known with hindsight. This is why maintaining the portfolio allocation to equities is so important.
Equity returns after bear
markets*
The opportunity today
As the chart above shows, the rewards from stocks are strong. Yet there are always divergences in the opportunities across the market. Today, smaller capitalization stocks, growth-oriented companies and technology stocks offer some of the greatest potential opportunities. As an active manager, we will begin to move more capital into companies like these as we get more information on the trajectory of the key economic variables. By doing so we believe we can unlock higher return potential as risks start to fade and equities inevitably begin a sustainable recovery and expansion.