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Volatile Market Defies Old-Favorite Investment Strategies

25 August 2008 - Features - Editor

The volatility of the market since October 2007, and more specifically during the past few weeks, has vividly illustrated that investor favorites of the past can no longer be relied upon and a varied investment portfolio is the wisest way to go. Many analysts have had to adjust their views as it has become apparent that the global market is not immune to the woes of the U.S. economy, oil prices can be dramatically influenced by changes in demand, and small-cap funds, which are generally avoided in tough times, are turning out to be a good investment choice.

International markets, which were considered to be a safe bet in the past, are taking strain amid concerns about slowing economic growth with speculation about a recession in places such as Japan and Germany causing concern. With indications that the dollar is strengthening against foreign currencies such as the Euro, U.S. investors with international investments may take a hammering in the months ahead as the foreign currency of their investment will be worth less when converted to U.S. dollars. For this reason, financial advisors often suggest that investors split their portfolio 75/25 with U.S. investments taking the lion’s share.

Consumers reacted to the drastic rise in oil prices, and the ensuing increase in gasoline prices, by cutting down significantly on their consumption, both in their vehicles and in air travel. So even though oil supplies on a long-term basis are limited, with the decrease in demand the price of oil dropped beyond the expectation of most analysts, which in turn, has had an effect on commodities.

In the past, when the U.S. stock market has gone through difficult times, investors tended to buy stocks in large U.S. companies which have substantial sales abroad. The reasoning behind this strategy being that small-cap funds are more vulnerable during tough economic times as they have less fat to cut and can flounder if they lose one or two key customers. Although this makes sense, the last month has shown that the Russell 2000 index has climbed by 7 percent while large-cap companies are up by less than 2 percent. Although this is a new trend, which will may or may not last, some analysts agree that small-caps may be benefiting from reduced costs as commodities decline. Also, larger multinational companies that previously benefited from attracting customers with cheap prices abroad will feel the effect of the strengthening dollar.

JP Morgan strategist, Thomas Lee, summed up the sentiments of many analysts when he stated that “In a nutshell, the balance of power (either bullish or bearish) remains fragile.”

 


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