Understanding the risk in disguise- How to safeguard your assets during market downturns

Understanding the risk in disguise: How to safeguard your assets during market downturns

By Marc Despallieres

Stability has never been an ally of equity markets, perhaps that’s why flat movements have been so rare in stocks. Markets can ebb and flow when constant and extreme volatility is followed by fundamental factors that are not in your control. Be it geopolitical scenarios, panic/confidence resulting from quarterly results, advent of government policy or the like, market movements are prone to arbitrary decision-making as predictions are more customary than consistent analysis.

Unveiling the correlation

It is well known that markets do not follow a steady pattern and that the price fluctuations of various assets may or may not be interlinked. Otherwise, chasing bull runs would have been a cup of tea. However, there are certain facts and understandings one might glean as a long-term market player. One of which is probably that markets are inclined to fall after consistent bullish run and vice versa. It is easy to forget that the stock market is not just a performance guide of the economy but a supply-demand site as well. If there are people making positive returns, there will be people who are making negative returns as well. But to gauge such returns, it is important to connect the dots, to compute what is the best option for a particular asset.

Say you bought a 3-year G-sec bond. During a recession, central banks may lower interest rates in an attempt to stimulate economic growth. Lower interest rates can lead to lower bond yields, as the fixed interest payments become more attractive relative to other investments. More often than not bond yields and equities have an inverse relationship. Strategizing the allocation of your assets keeping in view such correlations can further assist you in understanding what’s best for your investments.

Prioritizing asset allocation

Recession is often followed by layoffs, a drop in purchasing power and a decline in stock prices, leading to an overall fall in the performance of equities as an asset class. However, the market comprises of a vast spectrum of assets that do well in a slump. During an economic downturn, different asset classes tend to perform differently, and owing to this the overall market can become even more volatile and unpredictable. Through asset allocation you can spread your portfolio across different asset classes based on their risk-reward ratio. By strategic allocation one can protect the value of investments from the negative effects of a recession and potentially generate better returns over the long term.

Defensive stocks, such as those in the healthcare, consumer staples, and utility sectors, tend to be less affected by market downturns. Consider adding these types of stocks to your portfolio as a way to reduce risk during market downturns.

Maintain a long-term perspective

It’s important to understand that the stock market is cyclical and that downturns are a normal part of the investing process. Panic selling will only rob you the opportunity of long-term recovery. Human minds are inclined to emotional decision-making that often results in poor investing choices. Investing demands informed decisions based on sound financial principles, rather than reacting to short-term market movements or rumours. The financial markets can be volatile in the short-term, with prices fluctuating rapidly based on various factors such as economic data releases, geopolitical events, or market sentiment. Taking a long-term outlook can help investors avoid knee-jerk reactions to these short-term fluctuations and instead focus on the underlying fundamentals of the companies they are investing in.

(Marc Despallieres is Chief Strategy & Trading Officer at Vantage. Views expressed are author’s own.)