Q3 2021 Market Commentary Answers to Our Most Recent Client Questions

US stocks, as seen by the S&P 500, ended the third quarter unchanged, having shed over 4% in September as fears over the debt ceiling and the Fed’s options erased the summer’s progress. Certainly, the market environment has changed a lot over the past 18 months. Valuations are up, economic data is varied, and the prospects of potential Fed action are growing. In this quarter’s commentary, we will try to address the most common questions we are hearing from clients. In general, we advise against extrapolating short-term trends.

Q: The stock market has been strong and valuations are higher, should we remain invested in US equities or prepare for a deeper correction?

A: Valuations are indeed up. However, in our opinion, the change in risk profile of the underlying investment environment is the more important issue that investors should consider. Simplistic multiples-based valuation measures go up and down and can remain elevated for a long time. Understanding the investment backdrop is vital to returns in certain segments of the market.

Recently, the Fed confirmed its intent to reduce the liquidity infused during the pandemic. While the Fed is likely to keep interest rates low, a slowing of bond purchases will tighten monetary conditions and remove the tailwinds behind riskier segments of the market. Thus, high-flying, hype-based story stocks should be avoided as economic realities become more important. There is just too much downside and complacency in these stocks which, unsupported by a sustainable business, have a steep risk profile. Since Oak’s portfolios are very high-quality and constructed with a very long-term time horizon, they are well positioned given the change in the market’s risk profile.

Additionally, a rising tide over the past 18 months has lifted all boats. The loose monetary environment, stimulus efforts, and anticipation of the end of the pandemic propelled stocks. Some sectors, which were struggling (and thus lowly valued) prior to the pandemic, disproportionately benefited from the cyclical recovery. Yet as the economy normalizes, these formerly challenged sectors are likely to struggle and should be avoided. So too should the sectors at the epicenter to the latest crisis. Historically, the victims of the last market crisis may rebound sharply as the emergency abates, but they can then underperform for years. For example, retail stores were struggling prior to Covid and it is doubtful consumers will return to the mall in a post-pandemic world.

As far as predicting the next bear market, timing the market has an extremely destructive impact on long-term wealth creation. It compounds decision-making mistakes and creates unnecessary taxable events. Academic studies have shown that remaining fully invested is significantly more effective in creating long-term wealth than actively trading. In practice, market timing inevitably misses the tail end of a strong bull market out of fear, and then rejoins the next bull market late and with less capital. Our solution to this dilemma is to ensure we hold high quality companies with strong long-term prospects, while trying to avoid emotional decision making, and preparing for market changes through altering risk exposure, sector allocation and valuation tolerance. We prefer to be selective and own quality growth companies, a segment that tends to benefit at this stage of the bull market lifecycle.