How to Invest When Stocks and Bonds Both Fall

Think you're diversified with a portfolio containing stocks and bonds? Think again says Morningstar Investment Management's Dan Kemp

Emma Wall 5 July, 2017 | 9:10AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Ask the Expert." I'm Emma Wall and I'm joined today by Morningstar Investments Management's Dan Kemp.

Hello, Dan.

Dan Kemp: Hello, Emma.

Wall: So, we've reached the halfway mark in the year, can't quite believe with this far through 2017 and perhaps people are having a look at their return statements for June. And they may not be as happy as they once were because for domestic assets at least, both equities and bonds, are down over the last month.

Kemp: That's absolutely right. So, we've had a pretty good run so far in 2017 in a lot of assets. People would have been pretty happy despite the economic news we've had and despite some of the political news. People have generally looked through that, which is a good thing, focus on the long term, may become a little bit complacent.

But yes, in June, we saw a fall in U.K. bonds and also U.K. equities. So, bonds, they are not doing the traditional job of balancing out equity performance and we think that's because of valuations. Both assets are looking a little bit expensive, bonds looking really quite expensive. And so, there's not necessarily that historic relationship operating there.

Wall: And that's very important point to make because those of us who have a bit of financial nous might think of investing one-o-one; equities go up, bonds go down; equities go down, bonds go up. And that is all you need for a diversified balanced portfolio because rode over the market you may be able to make at least a net return. However, at the moment, it looks like both of those assets are going down. So, where do you go for diversification? Where do you go for protection?

Kemp: So, you're absolutely right. So, economical investment one-o-one is that art of diversification, but that's really predicated on the view that both types of assets are offering good value and at the moment, we are not seeing that. We're not seeing a lot of value in equities and we're certainly not seeing value in bonds. And so, if you're buying two expensive assets and expecting them to balance each other out, that's a little naïve.

And really while bonds are likely to do their job if we have a very severe market correction, people do tend to herd for safety then. We'd recommend a slightly more nuanced approach, really starting from valuations and building a portfolio from there rather than these heuristics of just bonds and equities balancing each other.

So, we still see some assets that look good value. Emerging market equities still look quite good value to us. Japanese equities, emerging market bonds and increasingly we are looking at other types of absolute return funds as maybe ways of diversifying returns. But really that old game of just equities and bonds might work in a crash but won't work so well in normal market conditions.

Wall: I suppose it's worth remembering as well that we're mentioning a one-month view which is never something that we advocate, both from editorial, for memo, for analysis point of view. Investors who are in it for the long term may perhaps take note of a one-month return but they should never govern or manage their entire portfolio based on that?

Kemp: Absolutely not. You're so right that people really shouldn't be looking at their statements at all if they can avoid it. Investment is a long-term game. But if they are looking at their statements, then yes, forget about what's passed, focus on what's ahead. Think about where valuations are now and that should give you some good opportunities to make money over the long term whatever the next days, weeks and months bring us.

Wall: Dan, thank you very much.

Kemp: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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