The S&P 500 index ended May flat, despite massive volatility in the public markets throughout the month amidst increasing angst around slowing economic growth and risks of runaway inflation.
The U.S. economy is on shaky ground. The specter of rising rates, weak consumer sentiment, slowing economic growth, and inflation have severely dampened risk appetite in public and private markets.
Asset values have decreased although the Federal Reserve didn’t begin “quantitative tightening”—planned reduction of its balance sheet—until June 1.
So amidst all the uncertainty, where should investors turn?
Let’s first look at the asset classes where investors should not turn.
Venture capital (VC) investments have witnessed a terrible performance in 2022. Implied valuations of U.S. venture capital investments are down almost 50 percent year-over-year, Morgan Stanley analysts wrote in a May 31 note to clients. This would be the worst year so far for VCs in 20 years.
That trails significantly the performance of publicly-traded technology stocks, with the Nasdaq 100 index—which is made up of more mature technology companies—down about 22.5 percent year-to-date through May 31, or down 7.4 percent in the last twelve months.
What about cryptocurrencies, Web3, the Metaverse, and the like?
Bitcoin, the biggest crypto by market cap and an asset that is definitionally deflationary, has declined more than 30 percent since Jan. 1. Smaller cryptocurrencies and digital tokens have also followed suit, with the collapse of TerraUSD and its sister token LUNA further shaking investor confidence.
In a recent investor survey by Deutsche Bank on what asset classes professional investors most prefer in a sustained inflationary environment, cryptocurrencies came in last in the asset classes quoted, with only 1 percent of respondents favoring them.
Early-stage technology firms—crypto or non-crypto—are bracing for a capital drain in the near future. Experts expect VCs, facing worsening portfolio performance, to prioritize using capital to shore up existing investments instead of deploying into new ones. And as less-sophisticated and less-focused VCs exit certain industries (e.g., VCs dabbling in crypto markets may decide to exit altogether), capital will be scarce and some startups will collapse if they mismanage their finances. High-profile VCs, including Sequoia Capital and Y-Combinator, recently communicated this exact message. In a May presentation given to founders, Sequoia gave them a playbook to bootstrap expenses and preemptively told founders that they should not expect rescue capital to arrive in time of need.
Of course, this environment is great for contrarian investors to go in and provide rescue capital with highly favorable terms. But this is only suitable for the most risk-tolerant, institutional investors—think Warren Buffet during the 2008 financial crisis.
For a peek into how the “smart money” is positioned, Bank of America’s monthly global fund manager survey results for May is unsurprisingly, very bearish. Growth optimism was at an all-time low (for the survey) and many fund managers cited stagflation fears. Managers also on average expected eight rate hikes in this tightening cycle.
As for the actual investments they prefer, fund managers were most bullish on (in order) cash, healthcare investments, commodities, energy, and consumer staples.
Cash—which loses value in an inflationary environment—is the best “investment,” smart money investors say.
They held the most pessimistic views on technology firms, equities in general, the Eurozone, and emerging markets.
The biggest rotations, or movement, month-over-month was into consumer staples and cash.
In the Deutsche Bank survey, which was a one-time effort on identifying the best investments to combat a sustained inflationary period, real estate came on top.
Property investments (cited by 43 percent) was followed by developed market equities (33 percent), gold (15 percent), and cash (4 percent). The only other asset classes mentioned were developed market corporate bonds, government bonds, and cryptocurrencies.
Real estate atop the list is reasonable given its reputation for holding up well in past rate hike cycles. It is a hard asset and the inflationary nature of rental income (for those holding real estate as investment) is resilient unless severe economic recession hits.
Gold, another hard asset, is traditionally seen as a haven but its price has been flat year-to-date. Most investors however would take flat performance over S&P 500’s 15 percent decline year-to-date.
As for stocks? Opinions are mixed, but one segment has been buying. A recent JPMorgan analysis showed that corporate insiders have routinely bought the dip this year. Insiders such as company board of directors, executive management teams, and corporations themselves (through stock repurchase programs). Without them, the U.S. stock market would have suffered even bigger declines this year.
Average investors buying stocks should focus on profitable companies in growing industries with low leverage and good management teams.
After years of index investing (achieving beta with the market) when the entire market rose, astute fund managers who can pick quality stocks should outperform going forward.
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