We have been sheltered at home for over half a year. I hope you’re keeping your spirits up! I also hope those affected by the smoke cyclone are staying well these days.
Bad news not only came from the fire and weather. The stock market finally took a hard-hit last Thursday after rising almost unimpeded for five months. I would say the market is long due for a correction. The real economy still faces a lot of uncertainties. Besides, there are less than two months until the presidential election. It’s not surprising to see volatilities picked up.
But we also must understand where we are in the business and credit cycle and how we should construct our portfolio consistent with our long-term goal and risk tolerance.
Every recession was caused by different reasons. But all recession resulted in liquidity issues and danger of deflation. To resolve the problem, the central bank injected liquidity into the financial market. In addition, the treasury department gave financial aid to small business and those unemployed. The advantage of United States doing this is that it can keep interest rate very low. Technology development, demographic trends and globalization kept inflation low in the past. Low inflation gave FED ample time before it needed to raise interest rate. If the economy is growing at a rate higher than the interest payment, we will see the economy recover. However, given the size of the quantitative easing this year, we may need many more years for the economy to fully recover. It’s good to hear that in his speech on August 27th, FED chair Jerome Powell hinted the FED will keep interest low and tolerate moderate inflation.
The low interest and moderate inflation are good for stock market, as witnessed a lot of times in the past. The overall stock market return may be relatively low compared to previous decades, but still preferable over bonds.
It’s always dangerous to bet big on just one asset class. It’s even more dangerous to chase hot asset class, for example, big growth technology companies for this year. By adding more asset classes, diversifying into small stocks and foreign countries, we can have better risk adjusted return in the long run.
As for the near future, we may find ourselves riding a roller coaster. Please try to keep calm.
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