Both S&P 500 and Nasdaq Composite Indices reached new highs again last week. Investors are much more optimistic after a six-year bull market. However, investors are wary that a market correction could derail their financial plan even though most of them believe their investments will perform well in 2015, according to a recent survey conducted by Natixis Global Asset Management. 67% of the people in the survey say they feel they lack a plan to protect their investments in the face of another severe market downturn.
We don’t believe a bear market is imminent, but the bull market is getting a little tired and valuation is getting more and more expensive. Investors need to prepare for a potential market correction. To build a good plan for managing downside risks, we will go back to 2008 to find out what worked and what didn’t work. The painful experiences are still fresh in investors’ mind. Table 1 shows the performance of various asset classes in 2008. There are a few interesting observations:
Table 1: Asset Class Performance in 2008
- The risky assets were highly correlated. During the financial crisis, investors rushed to safety and sold indiscriminately anything considered risky. Equities and high yield bonds declined significantly.
- Most of the alternative assets didn’t provide protection. REITs, MLPs, commodities, even hedge funds in general, which had provided less correlated returns in normal market conditions, followed the equity market down.
- Treasuries, gold and tactical strategies helped diversify risks. Benefiting from investors’ flight-to-safety, Treasuries and gold both gained. Macro hedge funds, which aimed to profit from tactically positioning across all asset classes based on managers’ assessment of macro environment, gained as well.
Based on those observations, a good investment plan with downside management should have some Treasuries or high quality bonds, some gold and some tactical strategies. It is expected that the Fed will start to raise interest rates sometime this year. As a result, the US dollar may get even stronger. Bonds or gold will not be good investment opportunities in the current environment. For investors who are concerned about market corrections, incorporating a good tactical/macro strategy into their portfolio could be a better and prudent choice.