Reuters An electronic board displays various countries’ stock indices outside a brokerage in Tokyo .
Every time the market suddenly jumps or drops — well sometimes even when it doesn’t — there’s always the expected long list of pundits and analysts that hit the airwaves and Internet rounds. What’s causing it? How far will it go? Is this just a bump or the start of something bigger?
Usually this is useless noise; there’s always market movement and its extremely difficult to predict. Instead, it’s better to have a good long-term investment plan, diversify and avoid emotionally driven actions.
That said, on rare occasions there are important trends that investors should be aware of. Even if your investing horizon is long-term, it’s never a bad thing to understand important trends in the market. Occasionally, these shifts could be the beginning of real changes in long-term macroeconomic trends.
These trends can deserve some consideration when planning your portfolio asset allocation. The long-awaited end of unprecedented monetary stimulus by the Fed is an example of one such trend and its onset can mean a lot to your portfolio and performance.
While overly simplistic, the current dip in the U.S. and world markets could be grouped into two causes — a normal overextended and overbought market situation resulting in a cyclical retraction, or perhaps more ominously, the beginning of a market response to the once-in-a-lifetime change in monetary stimulus.
With interest rates forecast to be raised as early as two quarters from now and the Fed’s bond-buying program ending, the end of stimulus is bound to cause a long-term revaluation of almost all asset classes from Treasurys and corporate bonds to REITs, U.S. stocks, emerging markets and even foreign currencies.
The former, a cyclical correction, may yield a good short-term buying opportunity as asset valuations become more attractive and justify a small tactical shift in equity weightings. The latter, though difficult to predict, is more problematic as it will have a large effect on your portfolio over the long term, especially for interest-rate-sensitive assets.
So how to tell which is the cause of the current decline? Normally there’s no genuine way to be sure. Real-world market responses stubbornly refuse to follow theoretical expectations. But in this case, there’s a unique opportunity to test this theory because of what happened last year — the taper tantrum.
Recall, in late May 2013, the Fed announced the beginning of an end, a tapering, to its $70 billion a month bond-purchasing program. What followed was a mini global panic that drove down asset classes across the board and served as an interesting lesson in how the market reacts to the end of stimulus.
During the approximate one-month duration of the 2013 taper tantrum, major asset classes from the S&P 500 to Treasurys to emerging markets and many more declined dramatically, as shown below.
S&P All assets dropped with emerging markets, particularly the fragile five, leading the loss. Especially notable however were defensive assets such as treasuries, utilities, and REITs falling heavily too, a victim of their susceptibility to interest rates increases.
J.J. Zhang's Winner Take All: Stock-market decline looks cyclical but still full of hazards
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