The stock market has had a rocky start to 2022. As of February 11, the S&P 500 is down 7.2% as investors appear unsettled by the shift in the Federal Reserve’s view on inflation. Inflation has run hot for a while, but the Fed has been slow to react. Now the Fed is focused on withdrawing extraordinarily supportive policy measures that have been in place since early 2020 and accelerating their plan to tighten monetary policy via interest rate hikes and balance sheet reduction.
The broad market’s drawdown seems tame, however, compared with more speculative pockets of the market—like innovative technology and so-called “meme” stocks, which are sharply lower. These extremely expensive stocks were high-flying just a year ago as the economy quickly bounced back from the COVID recession with the help of massive fiscal and monetary policy intervention. Now as stimulus is waning, they’ve been hit the hardest.
Unfortunately, many investors piled into these market segments around the time that they peaked. For example, after enjoying spectacular returns, Cathie Wood’s ARK funds had net inflows of $13B in Q4 2020 and $16.5B in Q1 2021, primarily into their flagship innovation ETF (ARKK). However, last year as speculative stocks began to wobble, ARKK declined 23%, and so far this year it’s down another 24%. Investors who have chased performance in Special Purpose Acquisition Companies (SPACs), biotech, cryptocurrencies, and various thematic funds have experienced similar drawdowns.
This herd mentality isn’t new. According to the Morningstar Global Thematic Funds Landscape report published in February 2020, only 45% of all thematic funds—ranging from artificial intelligence to clean energy—listed at the end of 2009 survived until the end of 20191. Of the funds that survived, just 26% beat the MSCI World Index, a global equities benchmark. So, the odds of picking a winning thematic fund were less than 12%.
These statistics are a good reminder of the danger in following the crowd, particularly in making a concentrated bet on expensive assets. The flashiest, high-growth assets are typically the riskiest. Their elevated prices can fall fast and far in response to dimmer prospects, change in risk sentiment, etc. As such, investors should consider them speculative assets and not depend on them to reach their financial goals.
We believe investors should create a core portfolio that is well diversified, mindful of valuations, and aligned with their personal goals. Diversifying across geographies, industries, and asset classes increases the resilience of portfolios through various economic scenarios and helps protect investors from a sharp selloff in one corner of the market. Paying attention to valuations provides a margin of safety and helps inform which investments are most attractive. Without clearly defined goals, investors cannot carefully balance portfolio risks with long-term objectives.
At Ronald Blue Trust, we strive to understand clients’ goals and implement a personalized investment strategy to achieve those goals. If you need assistance and would like to talk to a Ronald Blue Trust advisor, please contact us at 800.987.2987 or email [email protected].