Diversification should mean that the performance correlation is negative or uncorrelated. In other words, when one zigs, the other zags or just pays no attention at all. As interest rates fell, treasury bonds and the stock market we actually somewhat correlated although for different reasons.
Bonds rose as interest rates fell over years, but stocks rose on easy credit excess leverage. In 2007 as the first shots were fired in the subprime mortgage debacle that linkage began to fail as investors began to move away from risk to security with the US Treasury bond the ultimate security.
Lets look at the performance of asset classes over the past few years. The first chart is a look at how ineffectively the US/International diversification worked.
Not at all. The effects of globalization are seen clearly as a connected world provided an efficient (if not effective)interconnection of equity performance worldwide. As Warren Buffet says, it is only when the tide goes out that we see who's standing naked in the water.
The truly diversified market shows the effective non-correlated comparative performance of Treasury Bonds, Rydex Managed Futures and the S&P 500. In the worst financial melt down of our lifetime the diversified portfolio would have weathered the storm reasonably well.
The conclusion is that one should not mix diversification with performance seeking. The decision OF the asset class is more important than what is IN the asset class.
Within our model currently we are weighting domestic stocks more than foreign, technology more than manufacturing, but the true proof of a good portfolio will be the weighting of fixed income (and various durations therein) versus equity.
John Barnyak
President
www.stonehouseasset.com
