The Investment Scientist

Archive for October 2018

150106094958-market-correction-1024x576.jpgAs of yesterday’s closing bell, the Nasdaq Composite is already in correction territory, down more than 12% from its high. However, the other two indices have yet to reach the correction stage, which is marked by a drop of at least 10%: the Dow is down 8.4% while the S&P 500 9.4%.

I am going to look at the recent market drop from two perspectives: statistical and economical.

Looking through the lens of statistics, a correction is long overdue. Why? Well, the historical odds of a correction are once every two years, those of a bear market once every five years. Yet the last time we had a correction was in 2011, seven years ago. Is it well-overdue?

Looking through the lens of economics, there are two exogenous economic forces that are influencing the market. One is the Trump tax cut, the other is the Trump trade war. These two forces are driving the market in opposite directions.

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Recently, some of my clients asked me a very good question: “Why is my portfolio not doing as well as the S&P 500 index? Shouldn’t we invest more in US stocks?”

The answer is very simple. US equity is only one component of their portfolio, and it happened to do the best this year. The best component of the portfolio will always do better than the whole portfolio. That does not mean we should not diversify.

In fact, I hear similar questions all the time. Seven years ago, it was “Why didn’t we invest more in emerging markets? There’s no way the US market will do better than emerging markets.” Five years ago, it was “Why shouldn’t we put everything in gold? All of my friends are investing in gold.” In each case, I had to twist their arms to get them to stay invested in US stocks, and now they are thanking me.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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