When Diversification Doesn’t Work

There are times when diversification doesn’t provide the protection investors want. We saw an example in the last week.

All, or almost all, assets other than cash decline when real interest rates are rising faster than expected returns on other assets. This situation usually occurs when central banks decide to increase interest rates to slow the economy or investors believe central banks are about to take that action.

At those times, prices of all traditional investment assets are likely to decline as investors re-price them in light of the higher rates. On Sept. 9, investors apparently concluded that the Fed was going to increase rates at its September meeting. That caused investors to re-price all assets, and the new prices were lower than previous prices.

What’s more interesting is that investors changed their minds on Monday, Sept. 12, increasing the prices of most assets, and then changed their minds again on Tuesday to cause the prices of most assets to decline. Stocks, bonds and gold closely followed each other during this period.

There’s not much investors can do other than to recognize that these periods occur. Usually they are fairly brief. Though at times of crisis, such as the fall of 2008, they can be extended.

Investors need to realize that there are periods when diversification doesn’t work, rather than abandon long-term strategies. They also should consider having guaranteed income, such as annuities or a safety fund primarily of cash, as insurance against such periods.

The Data

This week, we received the first batch of manufacturing data for August. The manufacturing data has been bouncing up and down most of this year. When averaged out, all the fluctuations for the year indicate manufacturing is flat or slightly negative for 2016. That’s a substantial improvement from the relentless negative data of 2015 and much of 2014.

This week’s data for manufacturing were flat to slightly down. Industrial Production was -0.4% for August, and the manufacturing component also was -0.4%.

The Empire State Manufacturing Survey was -1.99, which is an improvement over last month’s -4.21, but still indicates the sector is very weak. The Philadelphia Fed Business Outlook Survey initially looked good with a positive 12.8 reading. But the details of the survey were mostly negative.

A strong second quarter in retail sales is being followed by a weak third quarter. For the last month, retail sales declined 0.3% after gaining only 0.1% the previous month. Even excluding autos and gasoline, sales declined 0.1%.

The Producer Price Index for the month was flat, and after excluding food and energy was up only 0.1%. The 12-month increase after excluding food and energy was up only 1.0%.

The NFIB Small Business Optimism Index declined slightly to 94.4. But details of the report weren’t as positive. Only five of the 10 components of the index improved. Among the negatives were substantially less optimism about the next six months, increased reluctance to expand and difficulty in filling open positions. The average level of this index over 42 years is 98, so it still is well below average.

New unemployment claims rose only 1,000, keeping the number near historic lows.

The Markets

Stocks didn’t have a good week. The S&P 500 fell 2.68% for the week ended with Wednesday’s close. The Dow Jones Industrial Average lost 2.64%. The Russell 2000 slid 3.84%.

The All-Country World Index lost 3.32%. Emerging market stocks lost 5.12%.

Clearly, diversification didn’t help this week. Long-term treasuries declined 3.79%. Investment-grade bonds lost 1.70%, while Treasury Inflation-Protected Securities (TIPS) fell 1.29% and high-yield bonds dropped 1.58%.

Meanwhile, the dollar gained 0.41%.

However, energy-based commodities lost 2.15%, broader-based commodities dove 1.60% and gold slid 1.70%.

Bob’s News & Updates

Next week, on Sept. 20, I’ll be making a presentation to the Pittsburgh chapter of the American Association of Individual Investors (AAII). Details, including registration information, are here.

Don’t forget the new MoneyShow Dallas is coming up Oct. 20-21. I’ll be speaking there. Registration is free.

If you read and enjoyed the second edition of my book, “The New Rules of Retirement,” consider adding to the list of five-star and four-star reviews on Amazon.com. One recent reviewer said, “Thorough and very clearly written. It has changed my plan for retirement in a significant way.”

Some Reading for You

Here are some entertaining details about Eddie Antar, a founder of Crazy Eddie’s electronics stores, who recently passed away.

This article has some new perspectives on the relationship between income, wealth and happiness.

This post provides some interesting details about which types of jobs increased the most since 2000. This related post examines the sources of inflation.

I comment and link to these and other items on my public blog at http://www.bobcarlson.net.