Diversification Shows Its Power with More to Come

Last update on: Jun 16 2020

Diversification is more important than it has been in some time. I expect the power and importance of diversification to continue and even increase. Fortunately, our portfolios have been diversified, and it has been paying off, as you will see in this month’s Portfolio Watch.

Investing seemed easy when all investors had to worry about was the Federal Re-serve, and the Fed mostly was supporting markets. Now, the Fed isn’t as powerful as it was, and there are many other forces for investors to worry about.

After more than a decade of quantitative easing and extraordinary monetary policy, the tools central banks around the globe use to combat recessions are fewer and much weaker. There is not a lot of room to reduce interest rates, and central bank balance sheets already are bloated.

U.S. stocks rose after the Fed decreased interest rates at its July meeting. But stocks soon declined after investors realized the reduction was only a quarter point and Fed Chairman Jerome Powell said the Fed was not committed to a series of rate reductions. Instead, it will monitor the economy and make decisions based on the latest developments.

Global stocks tumbled further when President Trump did not see sufficient progress to maintain a trade truce with China that was declared only a few weeks earlier. Stock prices slid even further after China responded by letting its currency decline sharply against the dollar, triggering fears the trade conflicts would include a currency war. Some analysts now refer to the conflicts as a second Cold War.

In any environment, those issues would be enough to worry investors and increase market volatility. But there are a range of other issues to worry about, any of which could escalate into a global crisis causing damage to the markets and economy. I’ll run through the other major worries. Europe’s economy continues to weaken and could be heading toward recession. Germany recently reported some of its worst economic data since the recession. Of course, there is the continuing drama of Brexit to worry about.

Italy remains in a fiscal crisis. The crisis was papered over and delayed last year, but new deadlines are approaching. Italy and the European Union need a more substantive plan in the coming months.

China has problems other than conflicts with the United States. Protests in Hong Kong persist. They could escalate into a civil conflict that challenges the mainland government’s authority. The protests put pressure on China’s government to be firm, which makes it harder to reach an agreement with the United States on trade.

Iran continues to struggle under sanctions imposed by Western nations and is responding by continuing aggressive behavior that triggered the penalties and is taking other troublesome actions. It recently seized commercial trade ships from Western nations by using military force.

The United States and Russia have a series of ongoing clashes. The most significant and enduring is what appears to be a cyber war. These clashes aren’t near settlement and could intensify.

Meanwhile, some longstanding regional problems appear to be worsening, such as Turkey’s conflict with the Kurds and Syria and the disputes between India and Pakistan.

Usually I say that since these and other problems are known, their potential effects are reflected in market prices. I don’t think that’s the case now.

Investors tend to project the recent past into the future. The long period of economic growth and rising stock prices since 2009 has trained investors to believe the Fed will support the economy and markets regardless of what else happens. They believe all we need are perpetually low rates and easy money.

Investors are likely to find that central banks are weaker than in the past and some problems can’t be remedied with easy money. This is a good time to recognize and benefit from the power of diversification and balance in your portfolio.

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