2014.. It was just one of those years… Divergence

  • Written by David
  • February 9, 2015 at 11:05 pm
  • 0
  • Something happened within the global financial markets during 2014.. Something Wall Street calls ‘divergence’.

    DEFINITION of ‘Divergence’
    When the price of an asset and an indicator, index or other related asset move in opposite directions.
    In technical analysis, traders make transaction decisions by identifying situations of divergence,
    where the price of a stock and a set of relevant indicators,
    such as the money flow index (MFI), are moving in opposite directions.
    Source: Investopedia


    It was during the middle of 2014 when divergence started in this current market cycle. International markets (both the developed and developing economies) along with specific U.S. markets such as small and mid sized US stock indices along with high yield (junk bond) indices all began to diverge from the S&P 500 Index.


    European Index: MS EAFE (Morgan Stanley European, Australia Far East Large Cap index) v.s. S&P 500 (blue line)
    Source: Yahoo Finance

    U.S. Small Indices: S&P 600 Small Cap and Russell 2000 v.s. S&P 500 (blue line)
    Source: Yahoo Finance


    Diverged from what?
    The  S&P 500 stock market index which comprises large US companies was one of the few major indices to continue to advance all through 2014. Divergence is viewed in many ways, one is that risk is increasing within markets, and therefore market participants wish to lower risk and sell particular assets. This process is what Wall Street calls, ‘taking risk off the table’. We saw this in 2014.


    To be sure, indices that declined in 2014 year were for a host of reasons, but one was global investor appetite for risk had begun to decrease. Here’s an interesting view on diversification, or the lack there of.. during 2014.


    When underperforming the S&P 500 is a good thing.
    Matching the index last year would have involved too much risk’
    Fact is, a truly diversified investment portfolio should have returned less than 5% in 2014. It was that kind of year. Any adviser who generated returns close to the S&P was taking on way too much risk, and should probably be fired.” 

    “Developed markets, as represented by the MSCI EAFE Index, fell 4.9% last year, and the MSCI Emerging Markets Index fell 2.2%.”

    “Applying allocations based on Morningstar Inc.’s five main target risk indexes, ranging from conservative to aggressive, the best performance last year would have been 5.23%, which includes a 1.51% decline during the second half of the year.”


    To read the full article from Investment News go here.


    Summing it up.
    Periodically markets diverge from one another. Often it occurs toward the top of market cycles as the economic future becomes more uncertain. I think 2015 qualifies as such a time period. Not withstanding the high valuations of traditional stock and bond asset classes today, over time, a diversified portfolio will at times outperform broad market indices and at other times, underperform such indices. 2014 was one of those years where the diversified portfolio underperformed.


    As always, thanks for reading.


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