Are You Prepared in case the Current Market Loses Its Steam?

Recent news headlines have repeatedly indicated that the uncertainties in the global political and economic policies are unprecedented. The uncertainties in the global investment markets have increased; however, the global stock market volatility has declined.  Many markets have reached new highs.  The situation is very unusual.

One of the problems is the commonly used market volatility indicator, which does not reflect the market risk.  More seriously, the low volatility will give investors a false sense of security and invest too heavily in the stocks.  When the markets lose the steam to go higher, any little negative news can send the stock prices down and leave investors unprepared.

Over the past four years, the central bank’s quantitative easing policy has also led to low market volatility.  The low interest rates, and rising asset prices, have led investors to favor high-risk assets. In recent years, the volatility of the stock market has fallen to a low level not seen since 2006.  Any sporadic “accident” will cause history to repeat and send the stock market to fall rapidly.  Investors must remember that the market still has potential risks.  Stay alert and vigilant.  Keep the investment portfolio well balanced and make necessary adjustment when needed.

The current market is brewing change. The US Federal Reserve has begun to tighten monetary policy.  The European and Japanese central banks have been aware of the limited effect on economic stimulation through the negative interest rates and quantitative easing policies.  They are beginning to consider to adjust their monetary policies.

The fiscal policies have also caused a variety of changes.  Since November last year, the stock market has had a lot of money coming from bonds to stocks.  Investors tend to invest in more volatile stocks, particularly, in the growth stocks. Fluctuations in other asset classes are rising, especially in major government bonds and money markets.  We have observed interest rates of the 10-year notes rising from 1.8% to 2.58%, and then falling to 2.32%, and then shooting up to 2.5% in a very short period of time.

This year, there are many events that are expected to cause significant market risks such as the UK’s Brexit and the French election, which will very likely increase market volatility.  However, increases in the market volatility are not necessarily a bad thing, which make a diversified investment portfolio becomes increasingly important.  When the stock market volatility widens, the correlation between the stock and the high investment grade bond will be reduced.  Since the correlation decreases, the benefit of diversifying investment in different assets increases.

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