The Importance of Offense and Defense in Challenging Markets
- Andrew Casteel CFP®
- Apr 8
- 8 min read
Concerns that a trade war will lead to a recession have spread around the globe.
The possibility of retaliatory tariffs is on investors’ minds, with China responding with counter-tariffs, increasing the odds of a worst-case trade war scenario. Markets in Asia and Europe have declined alongside U.S. stocks, and there has been a “flight to safety” as bond prices rise and interest rates fall.
In sports as well as investing, a winning strategy requires a combination of both offense and defense.
Defense involves maintaining a portfolio that can withstand different phases of the market cycle. Stock market uncertainty and unexpected life events are inevitable, so always being ready to play defense is important.
Offense, on the other hand, involves taking advantage of market opportunities that emerge from changing conditions. The irony is that while periods of market uncertainty may be unpleasant, they also represent times when asset prices and valuations are the most attractive.
Ultimately, portfolios that are tailored toward financial goals need both offense and defense. How can investors position in today’s market environment to both protect from risk and take advantage of opportunities?
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Portfolio balance and financial planning are even more important today
This chart shows the historical annual return ranges of the S&P Composite index, bonds, and asset allocations of these assets. The bond index is represented by 10-year U.S. Treasury bonds prior to 1976 and the Bloomberg U.S. Aggregate Bond Index from 1976 to the present. Each bar shows the min, max, and average annual returns over each stated time period, for each asset or portfolio. These are calculated using underlying monthly total returns. Periods longer than a year show annual returns based on their geometric means. *Note that this chart's methodology changed on April 8, 2025 - previously, the bond calculations showed the historical return ranges of a buy-and-hold approach for 10-year U.S. Treasury bonds. Date Range: 1945 to present Source: Clearnomics, Standard & Poor's, Bloomberg, Federal Reserve
Two of the key principles of long-term investing are diversification and maintaining a long time horizon.
This is showcased in the accompanying chart which depicts the range of historical outcomes across stocks, bonds, and diversified portfolios. It also shows how these ranges change when time horizons are increased.
For instance, it’s easy to see that over just one-year periods, the stock market can vary significantly, from gaining 60% in 1983 when the market recovered from stagflation fears, to -41% during the global financial crisis.
Moving beyond just one-year periods and a stock-only portfolio underscores why these are powerful ways to think about investing and financial planning. Diversifying might reduce the maximum returns an investor can experience, but it can also reduce risk.
This is evident in the balanced portfolio consisting of 60% stocks and 40% bonds. So far this year, the S&P 500 is 13.6% lower, but a 60/40 mix of these indices has declined only 6.2%.
This chart shows the annual total returns for varying asset classes. Asset classes included are MSCI Emerging Markets Index (EM), MSCI Developed Markets Index (EAFE), MSCI World Small Cap Index (Small Cap), S&P 500, balanced portfolio, fixed income, and MSCI World Commodity Producers Index (comm.). The balanced portfolio is a historical 60/40 portfolio consisting of 40% U.S. large cap, 5% small cap, 10% international developed equities, 5% emerging market equities, 35% Bloomberg U.S. Aggregate Bond Index,, and 5% Bloomberg Commodity Index.
After all, the goal is not simply to grow a portfolio at the fastest but most volatile rate, but to have the highest possible probability of achieving your financial goals. A diversified portfolio historically has a much narrower range of outcomes, allowing investors to better plan toward their goals.
Similarly, extending your time horizon by even a few years can have a significant impact on the range of outcomes. History shows that, since World War II, there has not been a 20-year period in which any of these assets and portfolios have experienced annual declines, on average. The same is true over 10-year periods for many diversified asset allocations. While this is only illustrative and is no guarantee of future performance, it clearly shows the importance of thinking long-term.
Volatility can create opportunities
This chart shows the CBOE VIX index, a measure of 30-day expected volatility of the U.S. stock market derived from S&P 500 call and put options. The chart also shows the one-year forward price return of the S&P 500 beginning on each date of the VIX index. Significant VIX levels and their forward returns are annotated. Date Range: January 4, 2010 to present Source: Clearnomics, Chicago Board Options Exchange (CBOE)
What about market opportunities?
The accompanying chart shows that the VIX index, often known as the stock market’s “fear gauge,” can spike on a periodic basis. These peaks correspond to sharp drops in the market, such as in 2008 or 2020. These are times when markets are the most nervous and, in many cases, investors feel as if the situation will never stabilize.
The chart above also shows the returns of the S&P 500 over the next year. As we discussed above, there is never any certainty about returns over any single year for the stock market. However, it’s clear that the greatest market opportunities often emerge when investors are the most worried. This is the heart of the famous Warren Buffett quote to “be fearful when others are greedy, and greedy when others are fearful.”
This is especially true if markets face liquidity rather than solvency concerns. Liquidity problems emerge when market declines force some investors - specifically those who use leverage, or borrowed funds - to sell other assets. In these situations, prices may decline even when the underlying fundamentals of an asset remain unchanged. These are classic cases where short-term market moves become disconnected from long-term outlooks, creating opportunities for patient investors.
It's important to note that this is not an argument for market timing. Even when the VIX is high, there is no guarantee that markets will rebound quickly. Instead, investors should view this as additional support for taking a portfolio perspective.
Market downturns often occur when valuations are the most attractive, and thus it can make sense to shift toward – not away – from these assets. Of course, what makes sense for a given portfolio depends on the specific circumstances.
Valuations are more attractive today
This chart tracks the S&P 500 price to earnings ratio. Earnings estimates are forward estimates over the next twelve months. The dotted line denotes the average over the full period. This data is calculated weekly. Date Range: January 22, 1985 to present
Source: Clearnomics, LSEG
So, which assets have helped this year, and which are more attractive today?
Bonds have played an important role this year as interest rates have fallen, helping to balance portfolios and partially offset declines in other asset classes. Bonds are able to do this because they typically exhibit lower volatility than stocks and often move in the opposite direction.
For this reason, investors often say that “bonds zig when stocks zag.” Holding the right balance of “uncorrelated” assets helps investors prepare for challenging times.
Valuations are more attractive today after multiple years of strong stock market returns.
While it is still unclear where earnings will settle after accounting for tariffs, the price-to-earnings ratio of the overall S&P 500 has declined to 20.7x. Some sectors such as Information Technology, Communication Services, and Consumer Discretionary, have seen multiples decline more amid the broader pullback.
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Recent Declines Don't Guarantee More Declines Ahead
A critical point to remember is that when we experience market declines, we don’t know when the bottom will occur. If we could avoid being invested when the market is going down and then get back in when the market starts to go back up, that would be fantastic.
But without a crystal ball, that isn’t easy to pull off. The major risk we face attempting to time the market around drawdowns is that we may miss out on benefiting from the recovery.
This risk shouldn’t be underestimated. Figure 2 provides useful context. In Panel A, we take the same data from Figure 1 to show how U.S. stocks have performed on average in the 100 days following a market bottom at varying levels of decline (2.5%, 5%, 10%, and 20%).
Comparing the results versus the average over all the 100-day periods since 1926 (4.46%) highlights how the market tends to rebound quickly once it begins. For example, when the market has bottomed at a decline of 10% or more, the average return over the next 100 days has been 8.54% — nearly double the average over all 100-day periods!
In Panel B, we show the results of the same analysis applied to U.S. small-value stocks. We see the same patterns but with even larger magnitudes.
This is what tends to happen after market anxiety and uncertainty subsides. Discount rates (the return investors demand to hold stocks) can go down fast, sending prices up in a hurry.
Missing out on those times can have a big impact on investor results.
The bottom line?
Offense and defense are both important in times of market uncertainty.
They help investors manage risk and take advantage of attractive opportunities that may emerge from short-term periods of market fear.
In the long run, we believe holding an appropriate portfolio and working closely with your financial advisor to ensure that your financial plan is aligned with your goals is still the best way to achieve financial goals.
About the author:
Chief Investment Officer
Andrew is the Chief Investment Officer for Covenant Wealth Advisors and a CERTIFIED FINANCIAL PLANNER™ practitioner. He has over 11 years of experience in the financial services industry in the areas of wealth management and financial planning for retirement.
Disclosures:
Covenant Wealth Advisors is a registered investment advisor with offices in Richmond, Reston, and Williamsburg, VA. Registration of an investment advisor does not imply a certain level of skill or training. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. The views and opinions expressed in this content are as of the date of the posting, are subject to change based on market and other conditions. This content contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected. Please note that nothing in this content should be construed as an offer to sell or the solicitation of an offer to purchase an interest in any security or separate account. Nothing is intended to be, and you should not consider anything to be, investment, accounting, tax, or legal advice. If you would like accounting, tax, or legal advice, you should consult with your own accountants or attorneys regarding your individual circumstances and needs. The source of this article is from Clearnomics and and Avantis Investors and edited by Covenant Wealth Advisors. No advice may be rendered by Covenant Wealth Advisors unless a client service agreement is in place. Hypothetical examples are fictitious and are only used to illustrate a specific point of view. Diversification does not guarantee against risk of loss. While this guide attempts to be as comprehensive as possible but no article can cover all aspects of retirement planning. Be sure to consult an advisor for comprehensive advice. You can not invest directly in an index and illustrations in this article do not reflect fees or expenses.