volatility – Anu Maakan

Is DIVERSIFICATION the answer?

TESLA lost more than 10% of its stock price on 25^th January 2025, a day after it declared its quarterly results for Q4 2023. Poor financials driven by higher costs, competition and sluggish sales in international markets resulted in a thumbs down.

This may have meant a 10% loss in portfolio value for someone who only held TESLA stock. For others, it could have been the loss of as little as a few hundred dollars depending on how much they had invested.

‘Do not put all your eggs in one basket’, as the cliched saying goes.

At best, diversification is a risk reduction mechanism. It allows us to spread our investments to minimize the impact of poor performance from one or more of the investments.

On that theme, let’s say we invest into a family of hens and chickens to provide us with breakfast eggs. They do provide us the much needed, high quality breakfast……until one fine day when they catch a flu. If the flu virus then spread to the hen family, our investment would amount to 0. Might as well, have invested in a bank deposit alongside? Yes?

What kind of RISK?

Risk can mean different things to different people. A drop of 2% value could be high risk for those with a low risk tolerance. Volatility can be extremely stressful to some investors, while others thrive on finding opportunities in volatile markets.

Broadly, RISK refers to the possibility of losing money…….the risk of volatility and sudden losses; and the risk of compromising on returns or not being able to achieve our investment objectives.

A highly skewed, equity heavy portfolio may not give us the income we need and may lose value just at the wrong time. Similarly, a portfolio heavy on fixed income assets is prone to interest rate and inflation risks.

RISK is everywhere

Today, we are living with war, regional conflict, political instability, rising national debt and slowing economies, high inflation and several other risks. All of this impacts business, economies and performance of assets.

RISK affects performance of different assets in different ways and understanding this is crucial to achieving a diversified portfolio.

We could choose to spread our investments across stocks, bonds, bank deposits, real estate, commodities, cryptocurrency, art etc. Further, within asset classes we would need to look at diversification across large companies, small companies, geographic diversification, emerging markets etc. We could also diversify across different sectors/ industries, such as healthcare, technology, energy.

ASSET ALLOCATION is imperative

With the help of a financial planner / adviser we could come up with an asset allocation based on our financial goals, risk tolerance, our current wealth/ savings, investment experience etc.

As the SEC explains, “Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The process of determining which mix of assets to hold in your portfolio is a very personal one. The asset allocation that works best for you at any given point in your life will depend largely on your time horizon and your ability to tolerate risk.”

Each asset class comes with its peculiarities. For instance, commodities march to the beat of their own drum, which can help diversification. Supply movements can often be independent of the economic cycle. And while stocks and bonds may reward us with dividends or interest payouts, commodities do not offer this feature. Also, commodity ETFs may not come cheap, we may pay 0.8% a year in expense ratios for some of the more popular commodity ETFs.

How To Diversify Your Portfolio

While diversification can bring smoother returns, more predictability and reduced volatility in our portfolio it is important to remember that excessive diversification can be a losing game, it can mean lost returns/ potential for gain.

Yet, some risk may be necessary to meet our goals. For instance, if we are saving for retirement, it is likely that we will need to include some equity in the portfolio.

Determining our personal risk tolerance and investment goals is the first step. For example, we may be more inclined to invest in bonds or other fixed-income assets if we have a low-risk tolerance; if we have a higher risk tolerance, we may invest more in growth companies or early-stage start-ups.

Conclusion

Managing investments involves some science; we would benefit from using tools such as risk profiling, goal setting, diversification, asset allocation and periodic reviews with a financial planner.

As our portfolio grows and certain investments outperform others, it will be necessary to rebalance the portfolio to ensure that it does not become over or under exposed to the original plan.

A properly diversified portfolio can help us reach our investment goals and give us peace of mind.

Trends in global markets

We are witnessing extremely challenging times where cries of help, death and destruction are interspersed with financial troubles, inflation and yet progress, lives empowered by new technology, AI, new drugs and healthcare solutions.

The need for dominance (technological or otherwise), power play, regional conflicts and historical conflagrations are making for death, destruction, unstable geo politics, mistrust amongst trading partners, high inflation, energy shocks, human cost and displacement. Will this not impact your investments?

Here is a closer look at some key trends shaping our future.

Conflicts, Geopolitics and Volatility

‘This may be the most dangerous time the world has seen in decades and ongoing war in Ukraine and conflicts in the Middle East may have far reaching impacts on energy and food markets, global trade and geopolitical relationships’, said Jamie Dimon in a recent statement.

Central banks responded to the high inflation with the most aggressive global rate-hike cycle in decades; resulting in tighter credit, higher costs of doing business and forecasts of an impending recession.

Global debt has already hit a record $307 trillion in 2023. Experts predict more volatile business cycles, constraints on supply, shortfalls of demand and labour market shifts leading to economic fluctuations.

A bumpy economic landing seems inevitable as the economy sputters along; 6 out of 10 chief economists expect the global economy to weaken/ slowdown this year, as per the WEF.

As per this PIMCO report, ‘……..with the era of volatility-suppressing policies possibly over, markets are likely in for a period of heightened volatility, with an unusually large array of potential aftershocks.’

We would certainly do well to BUILD IN VOLATILITY into our investments decisions.

There are also reports of a drop in card spending in the US. Credit card spending was seen to be soft in September, across all sectors. ‘I think we are starting to see growing financial strain at the lower end of income levels’, said Citigroup economist Robert Sockin.

US – CHINA relations

The ever evolving US – China dynamic amidst the race for tech dominance continues to be at the cornerstone of geopolitics. This continues impacting the future of many corporations, such as NVIDIA due to the tighter restrictions on exports of hi tech items such as AI powered chips.

China is a larger story in itself. The slowdown and competition in China is beginning to impact the fortune of companies such as LVMH, Starbucks, Nike, Apple, Tesla, Rolex amongst others.

Barrons and The Wall Street Journal have reported these as impacted companies.

‘CASH is far from TRASH’

Last year was painful for fixed income investors in 2022 as they suffered losses on the back of rising interest rates. Higher interest rates have made holding cash more attractive, with many popular fixed-rate accounts paying over 5%.

Some banking stocks such as Bank of America and Goldman Sachs have benefitted from higher NII (net interest income) during this cycle of high interest rates.

Technology, Innovation, new DRUGS

In his recently published 7 page letter, “The Age of AI has Begun”, Bill Gates said that ‘The development of AI is as fundamental as the creation of the microprocessor, the personal computer, the Internet, and the mobile phone. It will change the way people work, learn, travel, get health care, and communicate with each other.’

Of particular interest are breakthroughs in AI, ML, Metaverse and VR (virtual reality), unlocking huge value across the business spectrum…. especially in healthcare, cybersecurity and semiconductors. There is a quiet convergence taking place – providing the grounds for a hyper connected, data driven world.

Recent drug discoveries and treatments in the areas of obesity, diabetes management, cervical cancer are heartening as they cater to huge markets.

Conclusion

‘Markets seem to be pricing the best of all worlds – inflation moderating, policy rates falling, and recessions evaded……. while attractive, the yield provided in ultra-short fixed income may be fickle, and kicking the can down the road on strategic allocations could prove costly for investors’, according to Goldman Sachs.

The key risk factors point to slower growth on the back of higher interest rates, ageing constraints for the workforce, geopolitical fragmentation of supply chains, technology led opportunities and disruptions. Mega forces are creating opportunities and risks across sectors and regions.

Yet, most agree that risks to growth are skewed to the downside and returns across asset classes are likely to be more differentiated.

The weakening case for equities amidst bank failures

HSBC is buying out the UK subsidiary of S.V.B. (Silicon Valley Bank) for £1. Yes!

Something must have gone seriously wrong? Yes!

Explained simplistically, S.V.B. invested large sums into long-dated securities. With the Fed’s drive to increase interest rates, its investments began to lose value and investors started to pull out funds. It was also functioning without a head of risk for several months.

Federal regulators have announced that all customers of both SVB and Signature Bank would have access to their money. The immediate turmoil in the US banking sector seems to have been arrested.

This episode raised additional questions for the sector. Are there other banks vulnerable to interest-rate risk? Will the acquiring institutions be as friendly to start-ups as S.V.B.? Who will start-up founders trust with their money….. and will they continue to be funded as before?

Let us not forget the underlying issues forces that led us here:

The Fed’s unrelenting focus on bringing down inflation via increasing interest rates (and hence the reduced valuation of bank stocks).
Poor risk management practices at some banks.
Reduced regulatory scrutiny on banks, following on from Trump’s populist era.

Jim Reid and a team of strategists at Deutsche Bank explained, ‘SVB’s woes are a combination of one of the largest hiking cycles in history, one of the most inverted curves in history, one of the biggest bubbles in tech in history bursting, and the runaway growth of private capital. ………. it’s just more of the boom-bust cycle we’re stuck in.’

In the aftermath of the 2008 financial crisis, Congress passed the Dodd-Frank Act to protect consumers. Wall Street chief executives, their lawyers and lobbyists spent millions trying to defeat it. Greg Becker, the chief executive of S.V.B. was one of them.

Biden has started to talk about bringing back more banking regulation!! When will those kick in? What will they entail?

Bank runs are considered quite dangerous because they may induce panic and concern amongst customers about their own deposits. In an interview on Sunday, former FDIC chairman William Issac said ‘there’s no doubt in my mind: There’s going to be more. How many more? I don’t know.’

There are big clues that there’s more pain to come, look to the market. There is potential for a cascade of bank failures, reflected in their shares prices on Monday.

First Republic, PacWest, Western Alliance, and Charles Schwab are among the major names that sank on Monday as investors grew anxious about banks’ ties to the tech industry and their massive unrealized losses. According to the FDIC, at the end of 2022 US banks were sitting on $620 billion in unrealized losses on their bond assets.

Moody’s Investors Service has downgraded the ratings of the collapsed Signature Bank to junk. It has also put the following six banks under review – First Republic Bank, Zions Bancorp., Western Alliance Bancorp, Comerica Inc, UMB Financial Corp and Intrust Financial Corp.

A volatile future!

Does the global economy remain a fundamentally sound place? Will there be more surprises in the stock markets?

Equity investing seems to have gotten more complicated and vol. Some factors to consider:

What about escalations in the Russia-Ukraine war and its impact on supply chains and cost structures across the world?

Will the inflationary risk and interest rate risk spill over to other sectors?

Could there be an impending funding crisis for technology companies/ start ups?

What about the impending recession, cost increases and unemployment resulting from central bank policy?

Could political tensions mount, especially that of US-China and in South Asia under China’s growing need to show dominance?

There seems to be a more stock market volatility coming our way and certainly not the tail end of bad news.