• Investing & Markets

Diversification is Key to Weathering Market Volatility

October 19, 2018 | Craig Birk, CFP®

We’ve recently experienced a sudden reappearance of big down days and also some big up days, and while it’s natural to try to find what is to blame, volatility often has no obvious cause, even when looking at it in the rearview mirror.

While it’s difficult to pinpoint what exactly causes volatility, the sell-off last week could likely be contributed to two speeches from two weeks ago.

The first speech showcase Fed Chairman Jerome Powell, who said that rates are still a long way from “neutral,” and that we are likely to go past it (“neutral” is usually thought of being somewhere around the 3-3.5% range). Keep in mind, the Fed has for nearly a decade found ways to be more accommodative, and it is likely that short rates will continue to rise unless economic data changes course significantly.

The second speech was delivered by Vice President Pence on China. It focused on Chinese election meddling, aggression, and unwanted behavior. Pence noted the ongoing – if not escalating – tensions between the United States and China, so trade conflict and tariffs are not only likely to go away soon, but could also intensify.

On the other side of rising rates and trade conflict, however, we’ve seen phenomenal earnings growth over the past few quarters. Big boosts and support for companies have come through tax cuts and keeping wage growth low, driving margins to the highest in decades.

The reality is, there have been six similar pullbacks in the last seven years – and each rebounded relatively quickly. This is why panic or knee-jerk reactions to market events like this are rarely good for your financial strategy. While the current bull market is the longest ever by some measures, eventually it will end. The interest rate environment and trade conflict have become bigger headwinds, and globally, the market has lost positive momentum.

This month’s pullback saw tech and other high momentum stocks hardest hit. Keep in mind, it’s not unusual for what sees the most success fall fastest when markets decline.  This is why diversification is so important – and a more diversified approach to U.S. stocks weathers the down days better. And of course, diversification at the asset class level helps even more.

It’s too soon to say that there is a true shift away from tech and momentum leadership. But eventually, as it always has, leadership will rotate. We can’t know if it’s happening next year or beyond – or if it’s already happened. Because of this, remaining diversified and rebalancing (which creates benefit from actual math, and not just guesses) are some of the best ways to ensure you’re in a good spot, regardless of what the market does and when.

For more information, read our free “Investor’s Guide to Volatile Markets”.

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