How To Diversify When The Fed Out Of Patience? by James Machuga, Merk Funds

The S&P 500 has more than tripled in six years, just like in 1929 and 1999-2000. What could possibly go wrong?

Our key concern at Merk is that as the Fed’s patience may end, volatility might pick up. This may be a threat to asset prices as our analysis suggests low volatility has been a key driver of rising stocks and bonds. Differently said, we believe the Fed’s accommodative policy has fostered complacency. Fear – the cousin of volatility – may come back to the market not only because the Fed’s attempt to pursue an “exit”, but also because of the uncertainty over the Fed’s future path of interest rates.

While increased volatility is ultimately a healthy development as it forces investors to think for themselves, it raises the question whether investors are ready. We encourage investors to check whether they are truly diversified. We’ve created the correlation map below to aide in your discussions.

Fed Diversify

Correlation is a measure of how assets move in relation to each other. Low or negative correlation indicates returns are less likely to move in tandem. This may smooth out overall returns of a portfolio, a potential diversification benefit. However, looking at correlations may only be a first step. Not only are correlations not necessarily stable over time, but there are other pitfalls investors might encounter.

We would like to invite you to join our Webinar on Thursday, March 26, 2015, entiled “What could possibly go wrong?” where, amongst others, we show how to construct a portfolio to weather more turbulent times.