Monday JumpStart: Bracing for PCE data, the BoJ and a health check on the Eurozone (5:44)
CIO's Christopher Swann provides an update on the Bank of Japan's historic decision to ditch negative interest rates and a health check on the Eurozone. Furthermore, this week, we await the release of the Fed's favorite inflation gauge.

Thought of the day

Risk assets have performed strongly so far this year. The S&P 500 has racked up 20 all-time highs before the end of the first quarter, and it closed last week with the largest year-to-date weekly gain of 2.3%. Both the Nasdaq 100 and the Nikkei 225 sat at record highs, while the STOXX Europe 600 was just 0.03% away from its own record.

There is no debate that markets have been doing well, and we still see a supportive environment for equities this year. Following the Swiss National Bank’s move last week, the Federal Reserve and other major central banks are also set to cut interest rates. Global economic activity is proving resilient, earnings growth remains strong, and the adoption of generative artificial intelligence (AI) has been rapid. In fact, since 1945, when the S&P 500 rose more than 6% in the first two months of the year, there are only 18 times when the benchmark ended up lower than when it started.

However, the current favorable financial environment won’t continue indefinitely, and geopolitics remain fluid and uncertain. We believe that only by diversifying across asset classes, regions, and sectors can investors effectively manage the risks in short-term market dynamics while also growing long-term wealth.

Diversification reduces risks. According to the UBS Global Investment Returns Yearbook, which analyzes financial markets going back to 1900, a portfolio diversified across 21 countries would have experienced 40% less volatility than an average single-country investment. Similarly, a portfolio with a 60/40 split between stocks and bonds has historically been less volatile than one that’s composed only of stocks. In fact, a 60/40 portfolio has only delivered a negative return over a five-year horizon 5% of the time, and never over a 10-year horizon. This compared with 12% and 5%, respectively, for equity-only portfolios.

Diversification helps catch the winners. Diversification is as much about not missing the right investments as it is about avoiding overexposure to the wrong ones. Over the past year, well-diversified investors have almost certainly benefited from the strong rally in AI stocks. Those with home-biased or concentrated portfolios may have missed out. Diversification is the only way to ensure that one does not miss the outperformers, and we believe this is particularly important in an era of economic and technological change. Ultimately, time in the market, not timing the market, is what delivers the most powerful results.

Performance-chasing is dangerous. Our brains are hardwired to find patterns, even in random noise. We also have a strong recency bias that leads us to favor new information over older information. Together, these tendencies lead to performance-chasing behaviors that are undesirable in longer-term financial planning. Currently, it may feel like the obvious way to invest is to overallocate to high-growth US tech stocks which a have solid profit growth outlook. But many investors may have forgotten that these same stocks saw a much bigger drawdown than the wider market in 2022. Looking at the annual returns of 14 major asset class returns since 1999, last year’s best-performing asset class has had a roughly 40% chance of experiencing a loss this year, versus around 30% for a well-diversified portfolio.

So, in addition to holding a diversified strategic exposure to the technology sector and to some of the likely beneficiaries of tech disruption, we think investors with excessive US big tech holdings should consider diversification opportunities in Asia’s tech leaders and quality companies in Europe and Asia. We also believe alternative assets should be a key component of long-term portfolios for those who are willing and able to manage the inherent risks such as illiquidity.