China and a Practical Way to Thoughtfully Diversify

China, welcome to the party
China wishes to be second fiddle to no other country. However, that’s exactly what the country has been for the last five years. As you can see in the chart above, an investment in the iShares MSCI China ETF (MCHI) has not fared so well.
Meanwhile, the American economy has been rip-roaring its ways to record-highs. In comparison, the largest 500 companies in America have been crushing China’s largest names. During the same five-year period, the iShares core S&P 500 ETF (IVV) gained approximately 79% while MCHI has lost money.
China says 不再 (no more).
In September, the Chinese central bank announced incredible measures to get their country back on track. These extreme economic measures reminded me of the unprecedented steps the US government took during the 2008-2009 financial crisis and again during COVID. Although not perfect in every regard, these measures led to generous investor enthusiasm and recoveries here at home.
Could this be the bottom for China?
That, of course, remains to be seen. China is plagued by significant issues, including poor demographics, a shrinking population, large swathes of real estate completely abandoned/never lived in, and geo-political tensions. Their chokehold on their domestic companies makes international investors rightfully uneasy. Healthy skepticism is a rational outlook.
Yet, global investors have cheered the recent stimulus by driving MCHI briefly past its 2022 and 2023 all-time highs. All this after experiencing its five-year low in January of this year.
That’s a good sign of investors betting on future economic growth with today's dollars.
Alas, I don’t think we can predict whether this will all work out in the long run. I’ve experienced enough in business (and life) to understand nobody knows anything about the future.
Instead of debating the long-term merits/demerits of China's economic plan, I’d much rather focus on the present moment. Right now, there is an ample amount of economic excitement and momentum in China and I feel it’s worth paying attention.
Different strokes for different folks
There are two camps of reasonable investors. One camp will embrace the market roller coaster ride to secure as much wealth accumulation as possible. While the other camp wants their money to grow modestly while not seeing it go down too much. The difference between them lies in their goals, emotional tolerance, and acceptance of market faith.
I serve both types of clients. One group is no better than another, but it is important for you to understand why and how these types of clients need to be investing differently from each other.
If you are in full wealth accumulator mode, volatility is your friend. Specifically, upside volatility. The goal is to get as much out of the market as you can get. And, perhaps outperform the market if you get lucky.
For you, the equity markets are where the bulk of your long-term money needs to be. Investing too much in lower-returning (bonds), less-volatile (cash), asset classes can be counterproductive to your goals.
Simply put, if you diversify too much into too many asset classes, you'll be making many bets that are very correlated with one another. This can lead to an investor lagging the market, exactly what the wealth accumulator doesn't want.
However, if you are a wealth preserver, volatility is your foe. Downside volatility (aka bad market days/months/years) brings you heartburn and emotional distress. The impulse to get out before it gets worse loops through your brain and has you reaching for your phone, itching to speak with your advisor.
For you, limiting volatility to acceptable levels is the game. This is best achieved by diversification through low correlated asset classes. Hence, the reason behind many advisors using high-quality bonds to counter equity market risk.
Before I go further, it's helpful to understand what correlation means. Essentially, it's how two different objects either move together or move apart.
To achieve your financial objectives, you most likely need to invest a percentage of your money in equities. Thoughtfully investing in low correlated asset classes is akin to taking your stock market medicine. As the market falls, your money generally falls less, and you feel more comfortable during the down times.
There are side effects to the medicine, but it does the job.
What side effects, you ask?
It is important to know diversification does not automatically improve investment returns. The less risk you take, the less you’ll make. No matter how fancy and complex your strategy is, if you are doing something to limit your account fluctuation, you will have fewer gains. Anyone who promises otherwise is ignorant at best and manipulative at worst. Many of these "magic bullet investment strategies" wind up on this list.
To help you understand asset correlations, Guggenheim offers an online asset class correlation map I find useful. Correlation maps show how much asset classes have moved together, or moved apart, over a certain period (ten years in this case). While maps like these can be helpful, correlations are not static. They can and do change each year. Although large shifts are uncommon, it’s crucial to keep this in mind and to revisit correlations every year.
As you view the map, you’ll note investment grade bonds aren’t the only asset class to offer low correlations to US equities. Other investment buckets, like cash, commodities, and alternative investments, have too offered low correlations to the S&P 500 over the past ten years.
If you are an investor trying to calm down the equity market risk you must take, it’s important to consider all the diversification options available to you. With the advancements in market efficiency and investment technology over the last decade, the investing class can access alternative types of investments at lower costs than ever before.
If we can help you sort out how to plan your financial future, and provide guidance on what investments to use or avoid, please contact us by submitting a request on our home page.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
The MSCI US Broad Market Index captures broad US equity coverage. The index includes 3,204 constituents across large, mid, small and micro capitalizations, about 99% of the US equity universe. Indexes are unmanaged and cannot be invested in directly.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index. Indexes are unmanaged and cannot be invested in directly.
Beta measures a portfolio’s volatility relative to its benchmark. A Beta greater than 1 suggests the portfolio has historically been more volatile than its benchmark. A Beta less than 1 suggest the portfolio has historically been less volatile than its benchmark.
The S&P 500 is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. Indexes are unmanaged and cannot be invested in directly.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Bonds are subject to availability, change in price, call features and credit risk.
Alternative investments may not be suitable for all investors and should be considered as an investment for the risk capital portion of the investor’s portfolio. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses.
The fast price swings in commodities will result in significant volatility in an investor’s holdings. Commodities include increased risks, such as political, economic, and currency instability, and may not be suitable for all investors.