Global markets may have swung wildly in recent days, but we think the recent selloff in stocks and commodities is not a sign of imminent global recession. However, it may prompt the Federal Reserve (Fed) to postpone raising U.S. interest rates for a while longer. In the meantime, the basics of successful investing remain the same: Sticking to your long-term investment plan and maintaining a well-diversified portfolio should help you weather the market storm.
Read on for more of our perspective on the current market environment:
1. The basics of investing have not changed. The foundational steps for successful investing remain the same despite the current turmoil. These include having a plan, watching expenses, staying diversified, and making sure your portfolio composition is lined up with your risk tolerance and investment timetable. It can be difficult for investors to stay on track when markets are volatile, but at Schwab, we are here to help you do just that. If you have any questions about your portfolio or your specific situation, contact your Schwab Financial Consultant directly, or speak with a Schwab representative at 1-800-435-4000.
2. We do not believe the extreme volatility in global stock and commodity markets is a sign of a global recession. The weakness is the result of a combination of factors—concerns over weakening economic growth in China and its surprise devaluation of its currency, as well as plunging commodity prices. Because China has been an engine of growth for the global economy over the past decade, markets were rattled by signs that growth has slowed more sharply than expected. Investors also have been uneasy about the possibility that the Fed may soon raise short-term U.S. interest rates. However, the underlying drivers of economic growth in most countries are positive. Central banks around the world have cut interest rates, and lower commodity prices—especially oil prices—can help to spur consumer demand.
3. We believe the Fed is less likely to raise short-term interest rates in September as a result of recent events. U.S. economic growth has been solid and unemployment has fallen, which would argue for the Fed to begin raising short-term interest rates soon. Collapsing commodity prices and currency devaluations, however, suggest that the rate of inflation—a key metric for Fed policymakers—may fall further. Moreover, the Fed typically takes global financial conditions into consideration, and is more likely to hold off on a rate increase as long as markets are highly volatile.
4. China’s currency adjustment should not have a major impact on U.S. economic growth. China is not a major purchaser of U.S. exported goods or services. However, China’s actions have negative effects on emerging market currencies and bonds. Countries that are major trading partners or that compete with China also have devalued their currencies, putting downward pressure on global inflation.
5. The drop in global commodity prices should be positive for consumers, but is a negative for commodity producers in the short term. Prices for all types of commodities have fallen sharply this year. Increases in supply—thanks to increased production and the stockpiling of commodities over the past few years, in anticipation of stronger demand—have contributed to the selloff. Also, because many commodities are priced in U.S. dollars, commodity prices tend to decline as the dollar strengthens, reflecting the dollar’s increased purchasing power. Once prices reach levels at which excess supplies begin to decline, prices are likely to stabilize.
6. Bonds with high credit quality help to hold down volatility in portfolios. Bonds in general provide diversification from stocks, generate income, and reduce volatility in an overall portfolio. Not all bonds are the same, however. For most U.S.-based fixed income investors, underweighting securities from riskier sectors of the market, such as high yield and emerging markets, should lessen portfolio volatility. Holding a portfolio of “core bonds”—intermediate-term U.S. Treasury securities and investment-grade corporate and municipal bonds—typically provides diversification from stocks, and also should lessen volatility.
7. Investors should stick to their long-term plan and not react to short-term movements. The intraday price swings we’ve seen recently can be unnerving, but long-term investors should keep in mind that these movements are likely influenced by the high-speed trading practiced by some institutional investors. A well-diversified portfolio—one that contains an appropriate mix of stocks, bonds, cash, and possibly other asset classes—should be in a reasonable position to weather turbulent market periods. Portfolio rebalancing is a classic strategy that is designed to lower risk and potentially enhance returns. Investors should consider trimming holdings periodically in asset classes that have risen in value and are taking up an outsize portion of their portfolios, while adding to those asset classes that have declined in value and now make up a smaller portion of their portfolios. Investors also may want to take advantage of “tax-loss harvesting” strategies, by selling some securities at a loss to offset taxes on gains and income in taxable accounts.
© Charles Schwab
