The power of diversification: the week ahead

Markets hate uncertainty - and we’ve got that in spades at the moment. At times like these it pays to focus on the long term, and to adopt good investment principles - like diversification.

So far, so normal

We all hate it when the value of our investments falls. But we have to remember that this is normal. Being underwater is more common than we might think. And living with corrections is the price we pay for the long-run outperformance of shares over other seemingly smoother investments.

Shares rise about two thirds of the time. That means they are going the other way on around a third of days. Holding our nerve when the market is heading the wrong way is key to our long-term investment outcomes. It’s sticking with it, or better still topping up as prices fall, that allows us to benefit from the compounded effect of the equity market’s higher growth over time.

Over the past 100 years, we have been more than 5% below the most recent peak in the market a little over half the time. On a third of days, we are likely to be at least 10% below the latest high point. We’re in a bear market (20% or more down) around a fifth of the time.

That’s the context for the recent market wobble. What we are going through is par for the course. And almost certainly our own personal experience is very different from the headline market performance. Chances are it is actually rather better.

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Eggs and baskets

That’s because of the power of diversification. The market has been driven in recent years by the performance of a handful of very large, very influential technology stocks. When the Magnificent Seven were on a roll, they dragged the headline index higher. Now they are pulling it down because the big tech stocks have fallen nearly a fifth from their December peak.

But if instead of tracking the market capitalisation weighted index you had spread your investments evenly across the S&P 500 you would have experienced a much more modest fall of around 7.5% since December. Even better, anyone who had diversified geographically would have enjoyed the remarkable - and unexpected - outperformance of European shares which are riding high on hopes for fiscal expansion, spending on defence and infrastructure, lower interest rates and an improvement in China, a key export market for the region.

And it’s not just European shares which are riding high. Europe’s single currency is also on a tear, shaking off fears of parity with the dollar to stand at $1.09 as expectations firm up that the ECB will cut rates less than forecast as Germany rebuilds, while the Fed will cut more as American exceptionalism runs out of steam and the economy finally slows.

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On the radar this week

The extent of that US slowdown could become more apparent this week as the latest consumer prices data is unveiled on Wednesday. The consensus is for 2.9% inflation in February, a smidge lower than January’s 3%. Any lower than that and the odds of deeper rate cuts in 2025 will shorten. Until recently, the expectation was for two more quarter point cuts this year in America. Now, three cuts look more likely as the Trump Bump morphs seamlessly into a Trump Slump. There’s never been a better time to ensure your portfolio is well balanced.

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Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Investments in emerging markets can be more volatile than other more developed markets. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of  Fidelity’s advisers or an authorised financial adviser of your choice.