[Opinion] Protecting My Assets from Unexpected Future Volatility

The positive momentum in the stock market continues. The U.S. stock market is reaching new highs, and the Hong Kong stock market has risen more than 20% from its low in January this year, entering a technical bull market. While we do not want to disrupt this good atmosphere, it is always important to prepare for cloudy days after clear skies. Given the current financial market situation, it is an appropriate time to reassess portfolios and build all-weather portfolios to protect assets from potential volatility and stock market declines.

What are the causes of stock market volatility?

There are so many that they cannot all be listed. In addition to company-specific factors such as disappointment over corporate earnings and performance outlooks, common macroeconomic factors such as rapid monetary tightening, geopolitical conflicts, recessions, or unexpected events (Black Swan) also cause stock market volatility. In 2024, two factors?geopolitical conflicts and concerns over excessive monetary tightening?have increased market volatility.

From early this year until before April, stock market volatility remained at its lowest level in years. However, as the conflict between Iran and Israel intensified, international oil prices exceeded $85 per barrel, causing stock volatility to surge nearly 50% from its low at one point, and U.S. stocks fell about 5% during the first three weeks of April. Recently, cautious market trends have re-emerged amid concerns that the U.S. Federal Reserve (Fed) may not cut interest rates for the rest of the year or might even raise them.

Where should one invest if high interest rates persist?

The market is wary that the Fed’s fight against inflation is not over and that it may maintain a restrictive policy stance. Some raise the possibility of stagflation, where growth slows while inflation accelerates. Although the likelihood is low, if it occurs, it could cause significant market shocks and is considered a tail risk.

What is noteworthy is that whether in stagflation or reflation (where both growth and inflation accelerate), gold has historically performed better than other assets in environments of high inflation. During times like now, when inflationary pressures persist and geopolitical tensions in the Middle East escalate, crude oil is also a commodity to watch. Conflicts in the Middle East disrupt oil production and transportation, causing energy supply chain instability. Therefore, energy sector stocks are expected to serve as appropriate hedges against inflation and geopolitical risks.

How to respond to geopolitical risks and unexpected market shocks?

Intuitively, military conflicts seem likely to cause major market turmoil. However, statistics since 1940 show that although stock market volatility rises and declines are pronounced in the early stages of military conflicts, these declines generally subside quickly. Besides military conflicts, the upcoming U.S. presidential election in November and potential trade disputes if Trump, the Republican candidate, is elected are also recent major market concerns.

The positive point is that U.S. stocks generally performed well in years when U.S. presidential elections were held. Trump advocates imposing tariffs exceeding 60% on Chinese imports, reminiscent of the trade disputes with China during his administration in 2018?2019, which increased stock market volatility. However, despite U.S.-China tensions, from Trump’s election in November 2016 until the sharp recession caused by COVID-19 in early 2020, the U.S. stock market rose about 30%, outperforming Chinese stocks.

Black Swan events, which cause unexpected market shocks, make portfolio management difficult because their causes and timing cannot be predicted. Considering that no single asset class consistently outperforms others every year, a strong way to defend against uncertainty is to build and maintain a diversified portfolio across various asset classes in advance.

Is holding cash the right answer during a recession?

When a recession arrives and market vitality declines, many think cash is best. However, over the past 50 years, the most effective defensive assets during recessions have been gold and U.S. Treasury bonds, which recorded average annual returns of +19% and +12%, respectively, significantly outperforming cash (+6%) and U.S. stocks (-5%). Therefore, if the 10-year U.S. Treasury yield exceeds 4.25?4.50%, based on the 3-month outlook range of Standard Chartered (SC) Group, the parent company of SC First Bank, it should be used as an opportunity to increase allocation to high-quality bonds.

Staying in the market through a diversified portfolio is important

Generally, long-term investing inevitably faces market volatility, so the key to portfolio performance lies in how one responds to volatility. It is important to remember that stock market declines of up to 10% are not uncommon even outside recession periods. Panic-selling and prematurely exiting the market during downturns ultimately cause investors to miss the best-performing days, resulting in poorer performance than a strategy of staying invested. Therefore, rather than trying to time the market, keeping in mind that time in the market is more important for portfolio performance, adhering to investment principles and maintaining a diversified portfolio is the best way to achieve long-term financial goals.

Raymond Cheng, Chief Investment Strategist (CIO) for North Asia, SC Group

This content was produced with the assistance of AI translation services.