MEDIA RELEASE: The priority for investors should be rebalancing their portfolios to protect their wealth instead of positioning for a return of the good times, as now is a dangerous time to be adding risk, says Talaria Capital co-chief investment officer, Chad Padowitz.

Padowitz says while falling share prices have started to manifest opportunities at the stock level, the investment outlook remains poor and isn’t helped by the geopolitical environment.

“While I’m not an expert in geopolitics, you don’t need to be one to see that the world is an increasingly dangerous place,” he says.

“We cannot emphasise enough that if the market gives investors another opportunity to rebalance, they should take it. One of the keys to wealth creation is holding on to as much of it as possible in down markets so that capital can then work for you when things improve, as they eventually will.”

Padowitz says investor sentiment is currently at odds with portfolio positioning and valuations.

“For example, investors in US equities, the most important global region, are very pessimistic but have done little about it. Shares are at lofty percentages of household wealth. In fact, on some measures S&P 500 valuations have rarely been higher in its long and storied history,” he says.

“For those who had the smarts or the luck to be exposed to the S&P 500 in the period from the March 2009 low to the end of September 2022, the experience was golden. The two main drivers of the 12.9 per cent average annual capital growth were operating margin expansion and valuation. Between them they accounted for more than 50 per cent of returns.”

Padowitz says corporate profitability is now vulnerable and that, at the very least, it is hard to see how margins will make a positive contribution to long-run returns.

“Whether it is signalled by yield curve inversion, falling leading indicators, spiking unit labour costs or rising interest rates and taxation, near record margins are almost certain to come under pressure.

“When considering long-run prospective average annual total returns for the S&P 500 over the next decade, we modelled upside, central and downside scenarios. For upside we arrive at nominal annual returns of 6.1 per cent, 3.6 per cent for central, and -1.4 per cent for downside.

“To give an indication of expected real returns, we subtracted the US Federal Reserve’s inflation target of an average 2.0 per cent. This gives us a real return expectation in the range of 4.1 per cent to -3.4 per cent a year.”

Finally, Padowitz says the debate around inflation has shifted from an under-appreciated problem since the first quarter of 2021 to become mainstream, moving on from discussions about headline inflation to core inflation, and from ‘how transitory’ to ‘how persistent’.

“There are authoritative voices on either side of the argument. If forced to say, we would agree with the persistent inflationists mainly because it is wages that drive services, which is the key constituent of core inflation. But for the purposes of returns, we focus on the risk to earnings, the other claw of the pincer clamped either side of the equity market.”