One standard financial planning trope is that you should be diversified. Your stocks may drop during a bad economic spell, but your bonds will hold steady or increase in value, thus offsetting the equity slide. Alas, that hasn’t worked very well recently.
During the financial crisis, almost all asset classes moved in lockstep – down. That gave diversification a bad name. Lately, the different asset types are not tightly correlated, to say the least. But this time, that is of little benefit.
Returns are more muted in 2015, ranging from a slight loss to middle single digits, depending on the asset class. That is true even within different stock sectors. Still, there is no common path they follow.
What has happened within the global financial markets during 2014 and this year is something Wall Street calls divergence. In other words, asset classes move in opposite directions.
It was during the middle of 2014 when divergence started in this current market cycle. International markets (both the developed and developing economies) along with specific U.S. markets, such as small and mid-sized US stock indexes along with those for high yield (junk bond), all began to diverge from the Standard & Poor’s 500 Index.
The S&P 500, which comprises large U.S. companies, was one of the few major indexes to continue to advance all through 2014. One way investors view divergence is that risk is increasing, and therefore market participants wish to lower risk and sell particular assets. This process is what Wall Street calls, taking risk off the table. We saw this in 2014. People went for the presumed safety of the S&P 500 and U.S. Treasury bonds.
To be sure, indexes that lagged in 2014 did so because global investor appetite for risk flagged. An interesting Investment News article on diversification in 2014 noted that, using research firm Morningstar’s five model asset allocation – which range from conservative to aggressive – you would have returned 5.2%. In other words, diversification last year didn’t let you beat the S&P 500.
Periodically markets diverge from one another. Often it occurs toward the top of market cycles, as the economy looks iffy. I think 2015 qualifies as such a time. Notwithstanding the high valuations of traditional stock and bond asset classes today, a diversified portfolio will at times outperform broad market indexes and at other times, underperform. Last year was an example of where the diversified portfolio underperformed, but it won’t be the last.
Look how things have swung, although not showing a clear pattern.
Developed nations, outside the U.S. and Canada (which the MSCI EAFE index follows) had a poor showing last year, when they lost 4.9%. But this year, amid more optimism in Europe and Japan, their bourses are doing better. The index is up 6.3%.
Meanwhile, the Russell 2000, representing small companies, trailed large- and midcaps in 2014 with 3.5%. But as small-caps aren’t as exposed to U.S. multinational companies, which lately have suffered because the strong dollar shrinks overseas profits, in 2015 has advanced at a relatively more robust pace, 5.4%.
And the champs of last year are not doing as well this time. The S&P 500, for instance, was up 13.7% last year and this year it’s a mere 2.4% ahead.
Follow AdviceIQ on Twitter at @adviceiq.
David Gratke is chief executive officer of Gratke Wealth LLC in Beaverton, Ore.
AdviceIQ delivers quality personal finance articles by both financial advisors and AdviceIQ editors. It ranks advisors in your area by specialty, including small businesses, doctors and clients of modest means, for example. Those with the biggest number of clients in a given specialty rank the highest. AdviceIQ also vets ranked advisors so only those with pristine regulatory histories can participate. AdviceIQ was launched Jan. 9, 2012, by veteran Wall Street executives, editors and technologists. Right now, investors may see many advisor rankings, although in some areas only a few are ranked. Check back often as thousands of advisors are undergoing AdviceIQ screening. New advisors appear in rankings daily.