There are opportunities in every market, even the most uncertain
By John P. Calamos, Sr.
These are confusing times for investors. There are many big questions and little clarity: How much further will the Fed raise rates? Will the stock market maintain its rally or will it fall back into bear market? Will the United States enter a recession soon or has it already?
The past few weeks have brought encouraging signs that things could be looking up: gasoline prices have fallen, inflation appears to have peaked, and during this latest round of earnings announcements, corporations posted strong results that surprised on the upside. On the other hand, there was less optimistic news: CEO confidence measures and housing data pointing in a discouraging direction, and some well-publicized reports of layoffs. Stock markets are choppy, ending several days with steep declines.
I have both good and bad news for investors. Let’s get the bad news out first – the uncertainty isn’t going away. In fact, markets could become more turbulent as midterm election anxiety and fiscal policy unknowns add to geopolitical concerns, especially regarding the invasion of Ukraine by Russia and China’s strategic aspirations. Given this environment, investors should be prepared for the market to trade on a rollercoaster ride, with massive moves and wide trading ranges, not just this year but beyond.
Now for the good news: there are opportunities in every market. Creating wealth does not require a perfect economic environment. If that were the case, no one would ever make any money.
What we see today reminds me of the 1970s, when my career as an investor began. Markets have been extremely volatile, as shown in the chart below. In 1972, the Dow Jones Industrial Average, then the market’s flagship measure, hit a major milestone: 1,000. investors were struggling with inflation and a double-digit federal funds rate. Like the Greek mythological character Sisyphus who was condemned to roll a boulder up a mountain to bring it back down once he reached the top, the Dow Jones has struggled for years, breaking the 1000 mark in 1976 and 1981 but sliding precipitously thereafter. It wasn’t until 10 years later that the Dow Jones finally took off, buoyed by the tailwinds of favorable policy.
Lessons from History: Down Jones Industrial Average, 1970 to 1982
The DJIA crossed the 1,000 mark in 1972, 1976, 1981 and 1982. There were still plenty of opportunities to build wealth with a long-term approach and active management.
As difficult as those years were for markets in general, I still found ways to create wealth for my clients. Looking back, I would cite two main reasons, both of which strike me as equally relevant to today’s sailing conditions. The first was active management guided by individual security selection. The second was the use of alternative investment strategies within diversified asset allocation strategies.
The importance of active management
After a rough start to 2022, the US stock market has regained about half the ground it lost. However, the recovery was not synchronized. Many stocks are overvalued, while others are not. Some were punished too harshly by market players, and some probably received more credit than they were due.
During the first half of 2022, markets moved primarily based on macroeconomic forces, such as market participants’ interpretation of Fed comments or inflation data. And make no mistake, macro influences will always wield a powerful influence in day-to-day markets. However, we are seeing signs that investors seem to be paying more attention to company-specific fundamentals. For active managers like us, this provides our teams with the ability to add value through proprietary research and individual stock selection.
Small cap growth stocks are one area where we are seeing an encouraging change in the tide. Small caps faced strong headwinds earlier this year, but these were driven more by sentiment and macro factors than by fundamentals. This has led to significant valuation discounts and provides a rich hunting ground for Calamos Timpani Small Cap Growth Fund (CTSIX).
The opportunity for alternatives
In the 1970s, stocks and bonds were under pressure. Many investors felt there was nowhere to go. But there were – we just had to look for alternatives in less familiar places. For me, this led me to diversify my clients’ asset allocations into convertibles, which was essentially an alternative asset class. This was years before the emergence of the popular convertible indices we have today, and I worked to develop proprietary valuation models. What I found was that convertibles offered a path less traveled, but one that led to attractive risk-adjusted returns.
Today, I believe the merits of alternatives are stronger than ever and one of the wisest actions an investor can take is to consider establishing or increasing allocations to liquid alternative strategies. By providing access to more sophisticated strategies than those available for traditional mutual funds, liquid alternatives are a great way to improve risk management or increase return prospects. They can be used to address a variety of asset allocation challenges, whether on the equity or fixed income side of an asset allocation. For example, funds such as Calamos Phineus Long/Short Equity Fund (CPLIX) and Calamos Hedged Equity Fund (CIHEX) use a wide range of techniques to potentially profit from both the upside and the downside of the stock market. For fixed income allocation, Calamos Market Neutral Income Fund (CMNIX) offers a proven approach to seeking stable performance and income without the level of interest rate risk associated with traditional bonds.
Meanwhile, convertible securities continue to offer an alternative to traditional equity and fixed income allocations. As we explained in a recent article (“Convertible securities: market review and outlook”), an interesting landscape has emerged, creating opportunities for our bottom-up approach. With their built-in options, convertibles offer attractive, risk-controlled access to growing small- and mid-caps, with potentially fewer downsides than investing in the issuers’ common stock. Convertible issuers often have no other debt in their capital structure and well-capitalized balance sheets. Additionally, convertibles tend to have shorter durations than traditional bonds, which is an attractive feature in this rising rate environment. Actively managing convertible securities, as we do in Calamos Convertible Fund (CICVX), gives us the opportunity to blend convertible securities with attractive yields to maturity with convertible securities that have measured equity sensitivity .
A good rule to follow, especially in today’s market environment, is to think longer term. Don’t let short-term headlines, which cause a lot of volatility, introduce panic into your investment decisions.
Throughout my 50 years as an investor, there has never been a day when the market has not been faced with unknowns and assumptions. However, if you take a disciplined approach and don’t get caught up in the short-term noise, you don’t need certainty about the markets and the economy to achieve your long-term financial goals.
Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.