It's been a heck of a two-week period. Global markets began selling off in a way we haven't seen in some time last week. Both the S&P 500 and TSX fell 3.9% over the five-day period.
This week began with virtually all global markets falling heavily, particularly the Dow Jones Industrial Average, dropping over 1,500
----- the largest numerical (though not percentage) fall in its history.
In a surprising move on Tuesday, most markets rebounded strongly ending the day at least 1% higher. On Wednesday, most markets resumed their downward trajectory, and as of noon Thursday, most are 1% lower on the day.
The initial decline was likely triggered by strong employment numbers in the U.S., coupled with an annualized 2.9% increase in wages. Although both are positive economic signs, as with most things in economics, it's never that simple. Investors were likely acting in anticipation of future interest rate increases by the Federal Reserve. By discouraging borrowing, higher interest rates help mitigate inflation, which reduces the amount of money in circulation, which reduces the demand for goods and services, which...well, you get the picture.
At first blush, wanting to keep inflation in check at the expense of economic growth may seem odd. But slower economic growth is much preferred to hyper-inflation
---- a cancerous problem that can ravage an economy for decades.
If this seems complicated or convoluted to you, you're not alone. There is a reason we often joke, "If you ask 10 economists to predict future economic growth, you'll get 12 different answers."
Another likely reason for the volatility could be the historically high valuations of stock markets around the world, but especially in the U.S. Valuations at the end of January for the S&P 500 index were as expensive as they have ever been. High valuations make investors nervous because they know valuations usually fall back to historical norms. This is not to say a prolonged market decline is imminent. It's too hard to tell if that is the case.
Although the future is unknown, there are some things you can do to protect your portfolio. Rebalancing is one of the best risk mitigation strategies at your disposal. It allows you to take gains off the table and re-allocate them to cheaper securities that may rally back in the future. This won't prevent all losses, but rather, should provide a degree of protection against a potential market decline.
This strategy is especially important to use during bull markets, as prolonged periods of equity growth can quietly increase a portfolio's risk level without much notice. Some may argue it's better to wait until just before a correction to rebalance your portfolio. Unfortunately, research shows picking a market top is very hard to do.