The current market isn’t exceptionally volatile. ‘Jittery’ may be a better descriptor. Factors such as the weak dollar, low interest rates, and lingering trade tensions, may lead many investors to excessively fiddle with their portfolios.
Indeed, there are times when assets should be sold and profits should be recognized, but too much fiddling and change for the sake of change aren’t always rewarding strategies for investors. Many are tempted to chase the latest hot stock, but keeping an eye on the long-term ball is what really matters.
“One theory as to why trees don’t grow to the sky suggests that gravity is the limiting factor. The taller trees grow, the harder they have to work to overcome gravity to pull water through their roots and distribute it to their extremities,” writes Morningstar’s Ben Johnson. “Gravity has a similar effect in stock markets, though it goes by another name: fundamentals. Economic growth, earnings growth, inflation—these are the fundamental forces that shape markets. Markets will often defy fundamentals during shorter time frames, but over the long term there is no escaping them.”
Investors should think about the importance of fundamentals in their asset allocation journeys, especially with equity markets trading at high multiples. Meanwhile, the Federal Reserve has successfully pushed credit spreads back down to levels lower than they were pre-crisis, so fixed income investors are faced with low yields in a near-zero interest rate environment.
Other Factors to Consider
Investors should pay attention to the risk that comes with any yields that are above average, and consider a total return approach for portfolio construction since yield alone will not cut it.
“The fact of the matter is that it’s never different. Historically high stock valuations and historically low bond yields aren’t fertile ground for future growth,” notes Johnson.
As we try to return to normal after a volatile year, investors will have to consider new challenges, particularly in the fixed income market.
“Have low yields pushed you into risky sectors of the bond market in search of income? With junk-bond yields recently touching all-time lows, I am skeptical that investors are being paid enough to take risks in that corner of the bond market, among others. It might be time to de-risk your fixed-income allocation, especially as credit risk tends to be positively correlated to equity risk and can diminish the diversification potential of your fixed-income allocation,” adds Johnson.
Bottom line: consider stepping back. Quit overly tinkering with your portfolio.
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