How To Invest When Everything Is Falling

When there’s this much red flashing in the markets, part of you thinks it’s best to stay away at all costs. But the other part has got to be thinking: there are assets here that my future self will thank me for buying today…

Why’s everything selling off?

The markets have been dominated this year by two things: high inflation and the interest rate hikes that central banks are using to combat that inflation. Those two things are the reason why the economy is seeing a downturn, and why investors are selling just about every asset.

And it makes sense: inflation is corrosive for stocks and for bonds. A slowdown in growth is bad for stocks and commodities. And rising interest rates are bad for just about every asset. In this environment, everything falls, except cash.

Stocks, bonds, gold, and other commodities are all selling off. Source: Koyfin, Finimize.

The good news is that an environment where cash beats every single asset is highly unusual and unlikely to persist for too long. At some point, some assets will emerge as winners.

Take the worst-case scenario: soaring interest rates most likely will eventually do what they typically do: push the economy into a recession. As consumer demand falls off a cliff, inflation will likely taper low enough for the Federal Reserve (the Fed) to pivot and go back to cutting interest rates to support the economy and, importantly, the job market. In that environment, stocks and commodities will fall, but you could expect assets like treasury bonds and gold to do well (like they have in 2008).

At some point, some assets will recover (like gold and Treasuries in 2008)

Now take the best-case scenario: the Fed manages to raise rates just enough to slow down inflation, but not so much that it tips the economy into a recession. This is the dream scenario: the soft landing. In this case, stocks, commodities, and potentially even bonds are likely to soar. Everyone’s happy.

There’s just no environment where cash beats every single asset for a long period of time. If it did, who would bother investing in risky assets? People would stick to cash, companies would have limited means to finance new projects, governments' budgets would shrink horribly, and the economy overall would grind to an absolute crawl. There’s a reason why asset prices go up over the long term: it’s how they entice and compensate investors for taking risks.

Which assets should you buy?

This is only the million-dollar question if your investment horizon is short and you’re seeking high returns. If that's the case, then you have to pick the right asset because over the short-term, some assets will go up, some will go down, and very few will generate high returns. And with all the macro uncertainty, picking the right ones has rarely been so challenging.

But if your horizon is long, and you’ve got reasonable return expectations, then as we showed here, a diversified portfolio of global stocks, Treasury bonds, gold, and other commodities should still deliver positive returns in most scenarios. That’s because, as you know, over the long term, asset returns have to beat cash. And over the medium term, a balanced portfolio will keep you from being overly exposed to any one macroeconomic environment, so you don’t need to worry too much about forecasting what the economy will do next.

And it gets better: in an environment like this one, you can see that as asset prices fall, the forward returns of that portfolio rise. Take stocks and bonds for instance. If they were overvalued a few months ago, they are trading at a more attractive valuation now. Those who buy at these discounted levels are likely to experience much higher returns than those who bought when prices were close to their highs. Those who'll buy at even lower levels are likely to realise even higher returns in the future.

How can you take advantage and profit from this market?

The truth is, in the moment, you won’t know whether prices have bottomed. And given how aggressive the Fed has to hike rates to tame inflation, there’s a fair chance that everything sells off a bit (or potentially a lot) more in the short-term.

But if you’ve got spare cash to invest, you should look at every fall in asset prices as a possible opportunity to build a robust portfolio at discounted levels.

If your time horizon is longer, and you don’t want to be too active in managing your portfolio, a good strategy could be to spread your initial investment out, and buy either at regular intervals, or when prices hit your targeted level.

Let’s say you’ve got $6,000 to invest in stocks. You could divide that money into three parts, investing the first $2,000 today, and plan to invest the other $2,000 blocks in three and six months, or if stocks fall by another 15% and 30%, whichever comes first. If stocks fall before your set investment times, you’ll have built your position at a lower price. On the flip side, if stocks recover while you’re still holding blocks of cash, you’ll have only missed the first few months of those returns.

Now if you apply that same strategy to your target mix of stocks, Treasury bonds, gold, and other commodities, you’re likely to build a robust portfolio at attractive prices. Your future self just might thank you.