Is rising confidence blinding investors to emerging risks?

‘The best time to adjust portfolios is when markets are calm’

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American Century Investments is cautioning investors to re-evaluate their portfolios ahead of a potential rise in stockmarket volatility.

With global economic and earning growth picking up steam owing to aggressive fiscal stimulus, accommodative monetary policy and pent up demand, Victor Zhang, chief investment officer at American Century Investments, said it is easy for investors to overlook the risks around them.

“From an investment perspective, recency bias can cause under-confidence or over-confidence in response to the most market recent events,” said Zhang. “We think there’s a lot to be optimistic about. Think how far we’ve come since the market hit its pandemic lows. Economies are reopening as vaccine distribution gains momentum.”

As a result, Zhang noted it is easy to see why the Conference Board’s most recent survey of multinational chief executives indicated the highest level of CEO confidence in the survey’s 44-year history.

Challenge assumptions

However, while maintaining there is a lot to be optimistic about, Zhang believes it is sensible to ask if this confidence has led investors to underappreciate emerging risks in the market.

“As we’ve learned yet again over the last 18 months, markets are dynamic and economic conditions can change quickly,” he said.

As a result, while American Century Investment’s chief investment officers generally agree with the Federal Reserve’s view that the current rise in inflation is transitory, Zhang argued it is vital to challenge assumptions and assess the downside of being wrong.

“Overall, the global economy is healthy and corporate earnings are on a trajectory to reach pre-pandemic levels later this year or in early 2022,” he said. “Still, we see the risk of higher inflation and interest rates as potential sources of volatility. And, after a year of stock prices rising in anticipation of a profit recovery, investor expectations are high leaving companies with little room to disappoint.”

Time to take action

While committing to a long-term strategy to meet financial goals helps overcome recency bias, Zhang added there a number of things investors should be considering at this current juncture.

For example has the portfolio been rebalanced after the large rise in equities? Additionally, should investors be considering deploying inflation-protected fixed income strategies or short duration multi-sector fixed income strategies?

“The best time to adjust portfolios is when markets are calm,” he said. “We think it’s a good time to re-evaluate portfolios before volatility returns.”