Sudden Market Dips Increase The Need To Diversify Your Portfolio

Is a consistently strong stock market in recent months a sign that we’re already coming out of the COVID recession?

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September’s Sudden Market Plummet: A Major Red Flag?

Or, after a meteoric rise in the summer despite the pandemic, was a sudden market plummet early in September a major red flag for the U.S. economy?

Between those two burning questions lies a vast expanse of market uncertainty unlike any we’ve faced before. Shortly before the Labor Day weekend, a rally one day was followed by big dips in the Dow and Nasdaq. It was a reminder of what some analysts had warned of weeks before: the big gains of summer weren’t sustainable.

Now the overarching question is whether the rally will get back on track. Some analysts think the market is at a risky point. Some worry that while the S&P is up about 50% over the past four years, much of the value in the market has been concentrated in tech companies. Others think the recession has come and gone.

Sometimes market history provides context and some comfort. But history doesn’t wholly apply now, because we’re living in unprecedented times.

In normal times, contrary to what many people believe, you could predict things like volatility ranges. Think about this: From 1949 to 1999, the U.S, experienced a 50-year run where the markets never dropped more than 30% in any year. One of the reasons for that was there was a level of certainty in terms of asset-class returns.

A Further Drop In The Markets

But that certainty has gone out the window. Because fundamentally now you’re looking at the most expensive market in U.S. history, as measured by virtually every metric. It’s also the most indebted market. This will be the only recession in U.S. history where corporate debt levels have risen and consumer debt has risen. It’s really unlike any other situation we’ve faced. Based on current market fundamentals, you could easily be looking at a market that could plumment from 60 to 70%.

But that being said, when you consider the massive federal government action taken this year in the wake of the pandemic, you could easily see a market that could be up by 40 to 50%, or even greater, inside the next two years. We have never looked at a market where the range of potential outcomes was as big.

Staying financially stable within this blurry future really comes down to diversification of your portfolio. Again, you have to consider the two extreme possibilities of the market. With a potential 60 to 70% drop, protection of capital is of the utmost importance. Yet at the same time, you’re dealing with a government that, between deficit spending and federal reserve printing this year, created between $13 trillion to $14 trillion out of thin air. So while we’re worried about collapse one one hand, we have to be productive with the assets we’ve got, because inflation will unquestionably be a problem going forward.

Markets Will Outperform Bonds

For diversification, it’s helpful to start with a fixed-index annuity, which is insured against loss. That’s the money that will be there no matter what happens. And if markets continue to go up, it will substantially outperform bonds.

Having a small portion of money in CDs, for immediate cash needs over the next 16 months, isn’t a bad idea. It’s also wise to have a section of your portfolio aimed at dividend-paying, traditional-type stocks. Another slice of the portfolio can be aimed at aggressive tech stocks, and a portion invested in precious metals, such as gold and silver.

If things worsen over the next few months, having solid diversification in your portfolio means a stronger safety net. You are not going to be sitting there looking at a life-altering loss. The market has had a big run, and when it hits bumps in the road, it’s a reminder to keep both hands on the wheel.

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