Pennsylvania Trust

Diversification Helps Mitigate Volatility and Points On Trade

Diversification Helps Mitigate Volatility and Points On Trade

The S&P 500 Index’s biggest one-day drop since Jan. 3 (-2.38%) was also a broad one, with more than 90 percent of stocks falling amid the escalating U.S.-China trade war.

The current bout of market volatility reminds us that a balanced approach is key to investing in the late-cycle period. While we still see room for risk assets to move higher, there are a growing number of risks that could cause an equity pullback. Bonds have continued to play an important role in cushioning portfolios during such bouts of volatility.

That being said, we need to remind ourselves that market volatility is normal. As we have pointed out in the past, a 5% dip occurs on average, three times per year (last occurred in December) while a correction of 10% happens on average, once per year.

Seeing trade talks are top of mind, here are a couple of talking points:

  • This latest stumbling block in negotiations underscores the uncertainty and fragility of the talks. While a deal may ultimately be consummated in the coming weeks, there is a good chance that negotiations continue for longer—recall that the U.S. and China have already been discussing trade relations for more than two years. In any case, both investors and corporate management teams will continue in limbo for the time being. For markets, the result should be periodic headline-driven volatility, both negative and positive, depending on the negotiations’ progress.
  • U.S./China disagreements are broad and deep. The thorny trade issues at the root of the dispute—corporate espionage, hacking, forced technology transfers, and intellectual property rights—were always going to be challenging to settle. Issues between the two countries are broader than trade and include disagreements over relations with Iran and North Korea, none of which will be easy to resolve. China has more to lose in an all-out trade war than the U.S., but Chinese officials won’t back down quickly.
  • Regarding the economic impact of a delayed consummation, it’s important to note that the U.S. is relatively trade insensitive, with most of its economy driven by consumption. China is more leveraged to trade flow. Last year we exported $180 billion in goods and services to China, which is 0.9% of our GDP. Meanwhile, China exported $559 billion to the U.S., which is 4.6% of its economy.
  • While U.S. growth has generally held steady, China has faced more headwinds. That said, the U.S. is not immune to trade—should trade disruption lead to tighter financial conditions (through higher inflation, lower consumer consumption, and higher financial market volatility) a slowdown could occur. It is this fear that triggered the risk off sentiment the market has adopted over the past week.

Disclosure: This Commentary represents a review of topics of possible interest to Pennsylvania Trust’s clients and is not personalized investment advice. It contains Pennsylvania Trust’s opinions, which may change following the date of publication. Information obtained from third-party sources is assumed to be reliable but is not guaranteed. No outcome – including performance – is guaranteed, due to various uncertainties and risks. This document is not a recommendation of any particular investment. Investment decisions for clients are made on an individualized basis and may be different from what is expressed here. Past performance is no guarantee of future results.