How Much Will China Affect Your Portfolio?

China Correlations

When Apple reported its fourth quarter earnings earlier this week, Tim Cook, the company’s CEO, noted signs of “economic softness” in the greater China region. Apple’s stock fell by more than 6% the next day. While China wasn’t solely responsible for this decline, it highlights how economic conditions on the other side of the world can affect US investors. How much will China’s financial travails affect your portfolio?

You can have direct exposure to China by owning stock in Chinese companies (for example through mutual funds and exchange traded funds). As Apple shows, you can also have indirect exposure to China through companies based in other countries. The iPhone maker gets almost 25% of its revenue from greater China (meaning China, Hong Kong, and Taiwan). Apple is something of an outlier, however; overall only about 2% of large US companies’ revenue comes from China.

The Chinese economy can also indirectly have an impact on companies around the world in other ways, such as by affecting commodity prices. So which countries are most closely tied to China? The graph above shows the correlations between the movements of Chinese stocks and many of the world’s other large stock markets during the past three years. Correlation is a statistical measure of how closely two things move together, where a correlation of 1 means they move in lockstep and -1 means they move exactly opposite each other.

Other countries in the Asia Pacific region—South Korea, Taiwan, and Australia—have the highest correlations with China. Interestingly Japan, China’s neighbor across the East China Sea, has the lowest correlation of the countries examined. The US is in the middle of the pack.

Perhaps the most striking aspect of these correlations, however, is that they’re all fairly closely bunched together. By contrast Chinese stocks have a correlation of only 0.35 with commodities, and a correlation of -0.14 with US investment grade bonds. That’s probably not because Chinese itself has a large effect on all the different countries’ stock markets, but rather that the same factors that affect Chinese stocks (such as the outlook for the global economy) affect stocks all around the globe.

So while some particular companies (such as Apple) and some particular countries (such as South Korea) may add some additional “indirect” China exposure to your portfolio, it’s important not to lose sight of the bigger picture. No matter what happens in Chinese markets, your investment performance is likely to be driven more by your broader exposure to different asset classes than by particular companies or countries.

3 Charts All Investors Should See

Glasses

In the space of just a few weeks, 2016 has already achieved several distinctions: worst ever start to a year for equities, a 20 percent decline in Chinese stocks and the lowest oil prices in well over a decade, according to Bloomberg data.

Given the abysmal start to the year, the defining question is whether this is another painful but temporary correction, or the start of a bear market. For now, I still lean toward the former.

That said the coordinated slowdown in global manufacturing, decline in earnings and deterioration in credit markets raises the risk of a more severe downturn. With that in mind, here are three charts to watch in assessing whether a bear market could be ahead.

 

Global Manufacturing Activity

Global Manufacturing

While services are stable and account for a growing share of overall economic activity, manufacturing is struggling in most countries, including the United States, as the chart below shows. This is problematic for several reasons. First, manufacturing data, particularly new orders components, are key leading indicators. Companies are quick to cut back when they expect demand to fall. As such, measures such as the Purchasing Managers Index (PMI) and the ISM new orders component typically lead economic activity by one to two quarters.

Another reason to watch the manufacturing numbers, particularly in the United States, is that the high yield market has a heavy weighting toward “old economy” companies. So, even if the broader economy is growing, a contracting manufacturing sector and falling capital spending could disproportionately hurt U.S. credit market conditions.

 

Earnings Revisions

Sector Earnings

Along with a contracting manufacturing sector and sluggish growth, Bloomberg data show we’re seeing the worst corporate earnings revisions since 2009. As I’ve discussed before, the U.S. is already in an earnings recession. While this would always be problematic, it’s even more challenging now given that U.S. valuations are still elevated. In addition, the Federal Reserve (Fed) is now tightening, and easing by other central banks isn’t having the same impact as previous efforts. In the absence of a significant expansion of monetary accommodation by the European Central Bank (ECB) or Bank of Japan (BOJ), market multiples are unlikely to expand. In other words, any further equity market gains will need to be driven by higher earnings. So far, as the chart below shows, we’re seeing the opposite.

 

Credit Spreads

US Credit

While China may have been the catalyst for the latest market volatility, credit market conditions have been deteriorating for 18 months, as evident in the chart below. U.S. high yield spreads are now more than double their trough levels from mid-2014, according to data accessible via Bloomberg. The widening of spreads and accompanying tightening in financial market conditions have contributed to the shift in the volatility regime. Should credit spreads continue to widen, particularly outside the already crushed energy space, this will arguably lead to more volatility and also raise more fundamental questions as to the health of the global economy.

For now, the bulk of evidence is still mildly positive. Most leading indicators are signaling an expansion, and the recent widening of spreads appears to already discount a likely spike in energy and material-related issue defaults. However, be sure to keep tabs on these charts going forward. Further deterioration in one or more of these measures would raise the odds of a more severe correction and potentially a more pronounced slowdown in the global economy.

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

 

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 2015 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader. BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

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Why You Should Keep Your Equity Sails Flying

Dock

If you’re saving for retirement, the idea of getting a 0% return on your stock market investments for a full year is downright painful. But that’s what happened to me, and millions of Americans during 2015. If you were in the U.S. equity market for the calendar year 2015, you got a lump of coal in your stocking at year end.

With the increasing drum beat about rising interest rates, I know that many investors are tempted to jump ship. Why leave money in equities, and risk another year of lost opportunity, when fixed income securities seem to be on the road to higher (and less risky) returns?

I’m always dismayed how many people view saving in their 401(k) as a race, where the object is to move from fund to fund in a continual effort to pick the fund with the best performance. But switching out of stocks because the news has been bleak implies some sort of ability to forecast markets, and guessing what the stock market will do over the short to intermediate term is near impossible. The fact that very few professionals are market timers (or successful market timers) confirms that difficulty.

HOW TO PREPARE FOR THE INVESTING JOURNEY AHEAD

Saving for retirement reminds me of a race where you know where you’re heading, but the conditions you’ll face along the way are anyone’s guess. Perhaps a good analogy would be a long transoceanic sailing race. You hope it will be all sunny skies and brisk winds, but you know there will be periods where there’s no wind, and you’ll drift backwards. The best you can do is set off with a range of sails that should work in a variety of conditions. Strong, durable sails for strong winds and large, lightweight sails to capture faint breezes. Of course it would also be nice to have a motor that will help you along when winds disappear.

This analogy works pretty well when it comes to my 401(k). The “sails” in my portfolio are various asset classes. I don’t know when each one will be the best performing asset class, but I feel better knowing I have diversified my portfolio to take advantage of whatever the markets throw at me.

TAKING A CLOSER LOOK AT EQUITIES AND STOCK FUNDS

So how much should you allocate to your equity ‘sails’? Although many of us just pull a percentage out of thin air, professionals use software to calculate the optimal equity percentage based on a given time frame. For those who don’t have portfolio optimization software just lying around, I have an easily accessible alternative: If your savings plan has target date funds as an option, find the target date fund that matches your time frame, and see how it allocates assets to equities. Not only will this give you an idea of how much you should consider to have invested in equities, it may also help you determine how to diversify between different components of the equity markets (small versus large, domestic versus international). Another option would be to see if your plan has an advice service, where you can get individualized advice for your specific time frame and financial profile.

BATTENING DOWN THE HATCHES BY INVESTING FOR THE LONG HAUL

Just as sailors have relied on ocean winds for centuries, stock market returns have been fairly reliable providers of long term account growth. Although it’s frustrating to endure months of market malaise, the reality is that the only way to get long term market returns is to be in the market long term!

And the motor? Well, I have one ‘investment’ that has a positive return each and every year. In many respects, my own contributions, and those of BlackRock, my employer, are a great investment in my savings success. No matter what the market has done, I can always rely on my account benefiting from the commitment I’ve made to max out my savings each and every year. Sure, I’d prefer that most of my account growth comes from the markets, but it’s great having two sources of propulsion!

Scott Dingwell is a Director in BlackRock’s Global Client Group where he serves on the U.S. and Canada Defined Contribution Team. He writes about retirement for The Blog.

 

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

Investing involves risks, including possible loss of principal. The target date in the fund name designates the approximate year an investor plans to start Withdrawing money. The allocation to asset classes in each fund rebalances every quarter and becomes more conservative over time as investors move closer to the target retirement date.

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What History Tells Us About Stock Market Declines

S&P 500 Index Declines 2

The start of 2016 hasn’t been pleasant for investors. Fears of a weakening global economy and turmoil in Chinese markets have led stock markets around the world to nosedive. The S&P 500 index of large US stocks has fallen almost 8.5% over the past three weeks. Such declines can be painful, and it may feel like it’s inevitable that markets will continue to head downward. But history suggests that investors who bail on the stock market at this point are likely making a mistake.

As we’ve noted in the past, when viewed in a broader historical context these kinds of declines aren’t too unusual. During the past 25 years the S&P 500 has gone down by more 8% over a three-week period at least once in a majority of calendar years. It happened 4 months ago. It happened in 2011, in 2010, and numerous times during the financial crisis. It happened in 2003, multiple times in 2002, and multiple times in 2001. The list goes on and on.

Sometimes these rapid market meltdowns herald more losses to come. The US stock market fell dramatically in January 2008, for example, and the pain continued the rest of that year. But many other times the market bounces back. Plunging markets in early 2003 and early 2009 both were followed by massive gains years in the subsequent years.

More often than not when the market suffers such acute declines, it recovers fairly quickly. In fact during the past 25 years when the S&P 500 index has fallen by more than 8% over a three-week period, it has averaged a gain of more than 17% during the next 52 weeks.

Of course averages don’t tell us what’s going to happen in any specific situation. It’s certainly possible that this year could end up more closely resembling the financial devastation of 2008 than the vigorous rebounds of 2003 or 2009. But if history is any guide, selling stocks for fear of further losses is more likely to be a mistake than a wise decision.

Exploring “Alternative” Fixed Income

Blackstone Graphic

Many investors have long held a somewhat traditional allocation to fixed income, consisting primarily of Treasuries, Munis, and investment grade credit—essentially a core portfolio. Over the last decade or so, as global fixed income markets have grown and investing in categories like high yield and other “spread” product has become more common, we’ve seen investors expand their bond allocation beyond the core, to core “plus”—including emerging debt (EMD) and high yield bonds.

But there’s another stage in the evolution of the fixed income portfolio, into what we are calling “Alternative Credit”—essentially a group of below-investment grade investment strategies that includes leveraged loans, commercial real estate debt, event-driven credit hedge funds, mezzanine, and distressed debt. These alternative strategies may also answer many of the questions fixed income investors are concerned about (regarding rates, yields and inflation), and may fit well into the type of bond portfolio they are considering for the future.

“Alternative Credit” is not meant to replace, but to complement the traditional allocation to fixed income. Their corresponding characteristics present an interesting set of features and benefits.

Where traditional fixed income generally works in more liquid, actively traded, efficient markets, alternative credit tends to focus more on less liquid, and thus less efficient areas of the bond market—where fund managers often deal directly with corporate management on a confidential basis to negotiate private covenant terms.

While traditional fixed income faces its greatest headwinds in environments of rising rates and higher inflation, alternative credit is often floating rate or has other characteristics that could mitigate its vulnerability to both rising rates and inflation.

And where traditional fixed income attempts to provide market-based returns from clearly identifiable indices, alternative credit largely involves unconstrained, benchmark-free pursuit of value based upon market-agnostic, company-specific credit events.

For these reasons, alternative credit generally operates in a different arena than traditional fixed income and can tap opportunities the traditional portfolio may otherwise miss.

4 Financial Fitness Tips for 30-Somethings

People Legs

Twenty years ago, I believe few people knew or cared what the “core” was, including fitness fanatics. Today when I go to the gym, or even the office, I see everyone balancing precariously on stability balls. As we’ve learned over the past two decades, core fitness is actually one of the key determinants of physical well-being.

When it comes to investing, your retirement plan could be considered the core of your financial well-being. To get this financial core strong and stable, you need to begin working on it much younger than you may think.

Saving for the day when work becomes optional should ideally begin the day you start work. While that may not be practical for many young adults struggling to pay off student loans, by your early 30s, you should have a regular saving and investment plan in place. This will set you up early and well to fund a multi-decade retirement.

With that in mind, just in time for New Year’s Resolution season, here are four financial fitness tips for 30-somethings.

Max Out Your 401(k) Contributions

In other words, put as much as you can into your 401(k). To put a fine point on it with some actual numbers, imagine a typical 35-year-old. As a starting point, assume this individual has $50,000 in a 401(k) plan, $5,000 a year in 401(k) contributions and a planned retirement at age 65. Over a 30-year horizon, assuming a relatively modest return of 5 percent, the difference between a $4,000 and $5,000 annual contribution represents an expected difference in terminal value at retirement of $70,000: $283,000 for a $4,000 contribution vs $353,000 for $5,000.

Avoid Holding Excess Cash in Your Retirement Account

Keep enough of an eyeball on your retirement accounts to ensure you don’t consciously, or unconsciously, end up holding too much cash. Everyone needs a cash cushion, but not in your retirement savings. Yes, stocks are volatile and maybe even expensive after a multi-year bull market. However, over a three-decade horizon, the difference in returns between a cash-dominated portfolio versus a balanced portfolio of stocks and bonds can be extremely large.

Given where rates are today, a very conservative, cash-heavy portfolio would struggle to generate annualized returns in excess of 2 percent. Take the illustrative example mentioned above. For that individual, over a 30-year period, a cash-heavy portfolio would lead to an expected terminal value at retirement of $212,000. Compare that to a more aggressive portfolio, mostly allocated to stocks. Even if the return on that portfolio was 5 percent, the expected terminal value after 30 years would be $353,000, more than 65 percent higher than the cash-heavy portfolio. In short, cash is great for emergencies and a cushion, but be sure to keep the cash stash out of your long-term retirement accounts.

Scrutinize Your Investment Funds for Unnecessary Fees

Active managers can add to market returns through security selection and market timing. However, if you have active managers that are doing little more than mimicking a popular index, such as the S&P 500, the higher fees associated with their funds are an unnecessary drain on performance. Going back to the previous example, assume that individual is paying an extra 0.5 percent in unnecessary fees compared to a set of cheaper index funds. By reducing the annual return 0.5 percent to 4.5 percent, a seemingly insignificant reduction, you reduce the expected terminal value of the retirement portfolio by roughly $30,000. The lesson: Watch fees and always look to minimize them.

Plan for a Longer Career

Nothing improves your retirement funding status more than extending your working life. Working longer accomplishes three things: increases your savings, adds years to compound those savings and reduces the years you’ll spend drawing down those savings.

In our theoretical example with a 5 percent return, working until 70 rather than 65 increases the expected terminal value of the individual’s portfolio from $353,000 to $480,000. If this individual extended retirement by another two years, the size of the retirement portfolio increases by another $50,000, to nearly $540,000. As we’re all living longer, it’s reasonable to assume those in their 30s today will comfortably work to 70 and even beyond. So if you’re in your 30s and already dreaming of an early retirement, reconsider. The longer you work, the better your retirement is likely to be.

While increasing your annual 401(k) contribution by $1,000, having a bit more stocks in your portfolio, cutting fees by 0.5 percent and working an extra couple of years don’t seem like major changes, their long-term impact can be huge. A bit more return compounded over a few more years will likely lead to a much stronger retirement plan. The bottom line: While none of these tips will have a large, or even visible, impact over the short term, over a 30-year horizon, their cumulative impact for today’s 30-somethings can be enormous.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

 

Investing involves risk, including possible loss of principal.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of January 2016 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

BlackRock makes no representations or warranties regarding the advisability of investing in any product or service offered by CircleBlack. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of any product or service offered by CircleBlack.

©2016 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.

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Investing in Interesting Times

Markets

There is a saying “May you live in interesting times” and we sure do, at least when it comes to the financial markets.  The first week of 2016 was the worst start to a year in the history of the S&P 500, down 6%.  This put the market back into correction territory (10% or more drop from its highs) where it was for a short period of time in August.  Interestingly, the more volatile Russell 2000 small cap index is down 19.2% from its high.  Many people consider a drop of 20% or more to be indicative of a bear market.

So where do we go from here?  Well, if history is an indicator then we have a fifty-fifty chance that the market will be higher at the end of 2016.  Since 1950 there have been 24 times that the S&P 500 was down at the end of the first five days of trading and in 13 of those times (just over half) the market ended the year up.  However, history does not drive markets; fundamentals, the economy and investors’ emotions do.  Outside the U.S. all three of these things are a concern, especially in China and the Middle East.  In the U.S., however, we see the economy as generally sound and growing; and fundamentals, while high on a historical average, are not out of line with where we are in an expanding economy.  Emotions of course are another matter!  Experience tells us that while investor sentiment and emotions tend to drive short-term volatility, over time it is the economy and fundamentals that will drive the market.

Trying to time the market is often difficult, if not impossible, because it is driven so often by emotions and a herd mentality.  I do find, however, that investors are often rewarded for purchasing quality companies when others are selling.   One of my favorite quotes from one of the best investors of our time, Warren Buffett, is “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”  January has clearly started off as a month when many are fearful.

So where to focus today?

As always it is important to evaluate your individual portfolio for adequate diversification to asset classes, stock and bond sectors, and regions of the world.  Within an adequately diversified portfolio and accounting for your particular time horizons and risk appetite I like and would therefore overweight:

  • US Equities – at current interest rates and with an expanding US economy it is better to be an owner than a lender. Within US Equities we suggest overweighting:
    • Technology – this sector continues to change and benefit society at a scale at least as great as the industrial revolution;
    • Financials – as interest rates rise there are many financial services companies that should see their profit margins increase;
    • Health Care – many baby boomers will live to 100. Medical technology and health care is allowing senior citizens to live more fulfilling and longer lives.  The companies that are providing and developing these solutions will likely benefit greatly from this reality;
    • Defense – terrorism is changing the face of what military and defense products governments are buying, but they are buying. Global terrorism is not going away in the near term and is only accelerated by what is going on in the Middle East and the high unemployment rates in many developing counties for males between the ages of 15 and 30.
  • Adjustable rate debt – as the Federal Reserve (the “Fed”) raises interest rates (we expect at least two more rate hikes in 2016 and the Fed is projecting four rate hikes) “fixed” income will be challenged. Also, as we have been saying for a long time, it is important to stay on the short end of the yield curve.
  • For municipal bond investors quality is important. There are a number of states and cities that if they were companies would be bankrupt and while it is possible that a growing economy will bail them out, I am fearful of at least one or two more “Puerto Rico” like defaults.

Final Thought

We often tend to take recent experiences and project them into the future.  As was pointed out by Ben Levisohn in Barron’s this week, we have just finished a two-year period with extremely low volatility as measured by the VIX (an index that measures volatility). Quoting Pravit Chintawongvanich he notes:

From 1990 through 2014, the market’s so-called fear gauge spent nearly a third of its time between 20 and 30, says Pravit Chintawongvanich, head derivatives strategist at Macro Risk Advisors. In 2013, however, the VIX spent just 1% of its time in that range, and in 2014 just 5%. As a result, when the big moves come, it “feels like the world is ending,” Chintawongvanich says. “In retrospect, the volatility is normal.”

Wishing each of you a blessed and prosperous 2016.

Susan McGlory Michel

 

Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.

Investing in Interesting Times

Markets

There is a saying “May you live in interesting times” and we sure do, at least when it comes to the financial markets.  The first week of 2016 was the worst start to a year in the history of the S&P 500 down 6%.  This put the market back into correction territory (10% or more drop from its highs) where it was for a short period of time in August.  Interestingly, the more volatile Russell 2000 small cap index is down 19.2% from its high.  Many people consider a drop of 20% or more to be indicative of a bear market.

So where do we go from here?  Well, if history is an indicator then we have a fifty-fifty chance that the market will be higher at the end of 2016.  Since 1950 there have been 24 times that the S&P 500 was down at the end of the first five days of trading and in 13 of those times (just over half) the market ended the year up.  However, history does not drive markets; fundamentals, the economy and investors’ emotions do.  Outside the U.S. all three of these things are a concern, especially in China and the Middle East.  In the U.S., however, we see the economy as generally sound and growing; and fundamentals, while high on a historical average, are not out of line with where we are in an expanding economy.  Emotions of course are another matter!  Experience tells us that while investor sentiment and emotions tend to drive short-term volatility, over time it is the economy and fundamentals that will drive the market.

Trying to time the market is often difficult, if not impossible, because it is driven so often by emotions and a herd mentality.  I do find, however, that investors are often rewarded for purchasing quality companies when others are selling.   One of my favorite quotes from one of the best investors of our time, Warren Buffett, is “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.”  January has clearly started off as a month when many are fearful.

So where to focus today?

As always it is important to evaluate your individual portfolio for adequate diversification to asset classes, stock and bond sectors, and regions of the world.  Within an adequately diversified portfolio and accounting for your particular time horizons and risk appetite I like and would therefore overweight US equities and adjustable rate debt. Within US equities we suggest overweighting sectors such as technology and financials. A full list of our suggested overweights as well as explanations for each one can be found at our website.

 

Glen Eagle LogoSusan McGlory Michel is the CEO of Glen Eagle Advisors, LLC. For additional information regarding Susan or Glen Eagle, visit www.gleneagleadv.com. If you are interested in scheduling a free portfolio review call 609-631-8231 or email info@gleneagleadv.com.

 

Disclosure: This commentary is furnished for the use of Glen Eagle Advisors, LLC, Glen Eagle Wealth, LLC and their clients. It does not constitute the provision of investment advice to any person. It is not prepared with respect to the specific objectives, financial situation or particular needs of any specific person. Investors reading this commentary should consult with their Glen Eagle representative regarding the appropriateness of investing in any securities or adapting any investment strategies discussed or recommended in this commentary.

How to Prepare for Volatile Markets

Volatility

The last few years have been a relatively calm period for the US stock market, with few of the large swings that characterized markets during the financial crisis and the subsequent few years. But if the start of this year is any indication, 2016 may be more turbulent. What should you do with your investments to protect yourself from that possibility?

The answer might actually be “nothing.” The first few days of a year don’t necessarily predict how the rest of the year will turn out. And larger market moves don’t necessarily mean you should make any changes to your portfolio. Markets go up and down all the time, and taking no risk with your investments would mean you wouldn’t have the chance to achieve more than meager returns. But if you are worried about market volatility there are a number of ways to try to combat it, some more advisable than others.

One way to try to protect yourself is to directly bet on volatility so that you’ll profit if markets become more tumultuous. These types of bets typically involve complex financial products such as options or exchange-traded products based on an index of stock market volatility. While betting on volatility can work in the short term if you guess correctly, it’s generally a terrible long-term strategy. For example, the iPath VIX Short-Term Futures ETN, one of the exchange-traded products tied to volatility, has lost more than 99% of its value since early 2009. Unless you fully understand how these types of products work and the unique risks involved, betting directly on volatility probably isn’t a good idea.

A second way to try to counteract stormy markets is to shift some of your stock allocation into “low-volatility” funds. These investment products have proliferated in recent years and hold stocks that historically have had been less volatile. These funds can indeed help reduce the impact of choppy markets, but there’s no guarantee that the stocks that historically bounced around less will outperform during any one future period of stock market instability. It’s also worth considering that some of these funds may shift your exposure not just toward less-volatile individual stocks, but also more broadly to less-volatile market sectors (such as utilities). Changing your sector exposure isn’t necessarily good or bad, but it’s something to be aware of if you’re thinking about low-volatility funds.

Perhaps the simplest way to prepare for market turbulence is simply to shift some of your allocation in higher-risk investments (such as stocks) into lower-risk investments (such as bonds). Shifting your allocation doesn’t mean completely abandoning stocks—you don’t want to make it impossible to achieve your financial goals if stocks actually perform well—but rather making slight adjustments so that you’re more comfortable with how your portfolio is positioned. After all, if the possibility of more volatile markets is keeping you awake at night, that may be a sign that your portfolio isn’t properly calibrated to your risk tolerance.