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By Rich Weiss - August 5, 2019
Global stocks suffered their worst declines of the year as markets reacted to yet another ratcheting up of the trade war rhetoric being exchanged between Washington and Beijing. Beijing allowed the Chinese yuan to devalue in response to President Trump’s decision to extend tariffs on Chinese goods. President Trump, in turn, responded with accusations of currency manipulation by the Chinese. Global investors’ sentiment decreased as the likelihood of a resolution to the trade wars faded and the possibility of a global slowdown increased.
To complicate matters more, in the U.S., the Federal Reserve (Fed) cut interest rates last week for the first time since the Financial Crisis, seemingly underscoring the risk to economic growth. At the same time, however, the language accompanying the rate cut seemed to suggest the Fed might be slow to cut rates in the future, disappointing some investors. Long-term bond yields, too, are pointing toward a significant economic slowdown. Finally, corporate earnings growth has ground to a halt. Amid this back and forth, the Dow Jones Industrial Average declined 2.90%, and the broader S&P 500® Index dropped 2.98% in one of the largest one-day declines in recent memory.
Perhaps in an effort to mitigate the effects of the U.S. tariffs, Chinese officials allowed their currency to devalue. The yuan declined to less than 7 yuan to the U.S. dollar—a level not seen in more than 10 years, and a psychological threshold for many traders and investors. In response, President Trump accused China, via Twitter , of “currency manipulation” and predicted that the move would backfire on China over time. A weaker Chinese currency makes Chinese goods cheaper for U.S. consumers, and it makes dollar-priced U.S. exports more expensive for Chinese buyers, all of which exacerbates the trade gap between the two countries.
This escalation in rhetoric and trade war tactics spooked global markets in Asia, Europe and then the U.S. Investors appear to be interpreting these events as indications that the trade conflicts are likely to drag on indefinitely, threatening global growth. Stocks had soared to all-time highs after recent signs that negotiations might be progressing, followed by another quick boost following the U.S. Fed’s announced rate cut. However, the new increase in trade tensions whipsawed global stocks and may be seen as a sign that heightened volatility will be with us for some time.
We know what’s happening, and we even know why it’s happening, but the question every investor is asking is, “What should I do about it?” When viewed in the context of a well-diversified portfolio and your larger financial plan, we believe the answer is likely “very little.” We never advise knee-jerk reactions to market events, especially if you’ve already appropriately set your longer-term course of action.
This may seem surprising when the market is going up or down by several percentage points each day. But consider that events a continent away don’t change your financial needs, and a well-thought-out saving and investing plan is just as relevant today as it was prior to these trade troubles. Rather than focus on the imponderables, like the next tweet or leg up or down in the yuan, investors are better served focusing on financial goals.
There are, however, times when it makes sense to change your portfolio allocations. Usually these changes have less to do with market movements or macro factors; they have more to do with where you are in your own life and how close you are to your financial goal. Consider retirement—the larger your account balance and closer you are to your retirement date, the more it makes sense to reduce risk. This is because you are nearing the end of contributions to your account and will have the longest time in retirement to finance. In those circumstances, it makes sense to reduce risk because a sizable market downturn could cost you years in retirement distributions.
Rebalancing is another potential response to market movements. This refers to the process of selling winning assets and buying underperforming asset classes in order to return to your predetermined asset targets. Consider the extreme case of the 2008-09 financial crisis. Then, stocks had historically poor returns while Treasury bonds produced some of their best results ever. To rebalance to our stated asset allocation targets, we would be selling bonds after a historic rally and buying stocks after an historic sell-off.
There are a few clear lessons to draw here. The first is that rebalancing enforces a sell-high/buy-low discipline, and the second is that it points to the benefits of making decisions in a structured way with buys and sells around a core position determined by our own financial goals and risk tolerances.
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Rebalancing allows you to keep your asset allocation in line with your goals. It does not guarantee investment returns and does not eliminate risk.
Diversification does not assure a profit nor does it protect against loss of principal.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.
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