Why buy and hold a globally diversified portfolio instead of reacting to breaking news? Political, social, and economic headlines come and go. But you never know which market segments will outperform from day to day, or even year to year. This makes global diversification your best strategy for seeking market returns, wherever and whenever they appear.
Breaking News and Globally Diversified Portfolio Views
We happen to be posting this Evidence-Based Investing Principles installment at the height of a shift in Washington, with the January 20th inauguration day fast approaching. Will Biden’s wealth-based tax proposals come to pass? Will stock markets rise or fall? What else is about to change? Hordes of professionals and amateurs continuously speculate on what all this and more will mean to investors.
What Recent Market Events Led to a Brief Bear Market in Stocks?
Let’s take a quick trip down memory lane—recent headlines delivered more plot twists than a daytime soap. For example, when tariffs were announced by President Trump in early April, investors everywhere braced for impact. The markets didn’t waste time responding: the S&P 500 tumbled close to 20% from its prior high, and the tech-focused Nasdaq slipped even further, entering what’s technically known as bear market territory.
Yet, as cooler heads prevailed and trade tensions eased between the U.S. and its major partners, recession fears began to fade. The markets slowly caught their breath and showed signs of recovery, with some analysts now suggesting a more optimistic outlook in the months ahead.
Too bad for them, the more surprising the news may be, the more erratically prices might swing in response. That’s the markets for you. Like a bucking bronco, near-term market returns usually exhibit more periods of wild volatility than a steady-as-she-goes trot.
In short, hanging tight to a globally diversified portfolio helps tame the beast. It can smooth some of the leaps and dives you must endure along the way to your expected returns.
If you’d like to see data-driven illustrations of how this works, check out “How to diversify your investments,” by financial author Larry Swedroe, and/or “When boring is good investing,” by financial author Craig L. Israelsen.
For a faster take, imagine several rough-and-tumble, upwardly mobile lines that represent several kinds of holdings. Individually, each represents a bumpy ride. Bundled together, the upward mobility remains, but the jaggedness along the way can be dampened (albeit never completely eliminated).
How Shifting Rates and Growth Can Shape Returns
With current market valuations running high and the outlook for profit growth looking a bit modest, it’s worth asking: What does this mean for broad stock market returns going forward? Well, unless interest rates fall further—an outcome that isn’t guaranteed—investors probably shouldn’t expect big gains to come just from rising stock prices or expanding price-to-earnings ratios.
Instead, the market may become less forgiving of general trends and more rewarding of individual company or sector standouts. In these conditions, the overall indexes might produce more subdued returns, while specific stocks or niche opportunities could outperform—especially those with unique strengths or growth stories.
As always, this is yet another argument for maintaining a diversified portfolio. Betting on one single theme, region, or type of stock risks missing out on whichever areas buck the prevailing slow-growth trend. Diversification remains your trusty saddle as the market trots—or bucks—ahead.
What’s Behind the S&P 500’s Upgraded Outlook?
So, what’s driving the latest boost in the 12-month outlook for the S&P 500? In classic market fashion, several moving parts are at play, and it’s not all crystal-ball work.
First, recession fears have mellowed, at least relative to the doom-and-gloom many expected a short while ago. With economists dialing down the risk of a looming recession, investors are recalibrating their expectations for corporate profits. Lower expected economic headwinds can, in turn, nudge company earnings projections higher—giving the S&P 500’s overall forecast a leg up.
At the same time, when uncertainty is perceived to be lower, the market tends to trim the risk premium investors demand to hold stocks. Think of it as investors feeling more comfortable buckling into the rollercoaster. This comfort can translate to a willingness to pay up for future earnings—pushing valuations higher.
Of course, don’t expect a smooth ride. With markets, volatility is always the ever-present passenger (sometimes uninvited, sometimes loud). While there’s reasonable potential for upside, the journey is likely to keep everyone on their toes. That’s yet another argument for spreading investments across geographies and sectors—helping to buffer the bumps as you seek stronger risk-adjusted returns.
Are High US Stock Market Valuations Justified?
This brings us to one of the perennial debates: Are today’s lofty US equity valuations truly justified by what’s under the hood? Looking back over the last decade, it’s hard to ignore that US stock prices—especially when measured by price-to-earnings ratios—sit near their historical peaks, easily in the upper range of past readings.
But context matters. Much of this is powered by corporate earnings, not mere speculation. The surge in profits, particularly from America’s largest and fastest-growing technology companies, has significantly lifted overall fundamentals. In other words, the market’s high pricing has, so far, been accompanied by genuinely strong performance from major players.
Does this mean we’re in a speculative bubble? Not necessarily. While high valuations can give any investor pause, today’s levels reflect a reality where profitability—especially in tech—has soared, not just investor exuberance. As always, it’s important to stay focused on fundamentals rather than headlines, and to remember that even justified valuations come with their own set of risks and bumps.
What Drives Structural Downturns in Equity Markets?
So, what tends to bring about those major, market-wide downturns—the kind that can shake even the most stoic investor? Typically, it’s a one-two punch: inflated asset bubbles coupled with widespread private sector borrowing. When both crop up together, the market becomes much more vulnerable to prolonged downturns.
Fortunately, in the years since the financial crisis, things have looked a bit sturdier on several fronts. Banks have been reined in by stricter regulations, leading them to bolster their reserves. Many companies—especially the ones you read about on the business pages—have cleaned up their balance sheets, and the average household, at least for now, is less leveraged than in previous boom-and-bust cycles.
Still, it’s wise to remember that while strong balance sheets help, markets are unpredictable by nature. Staying diversified is your best bet for weathering those rare but significant storms.
What Drives Current Recession Risk?
Trying to read the economic tea leaves in real time isn’t easy—bear markets rarely take the courtesy of dropping in a straight line, and markets have a knack for throwing in strong rallies just as you start to think a trend is clear. Where do things stand now regarding recession risk, both in the U.S. and around the world?
There’s some good news: recession chances have eased off a bit. A major factor behind this is the recent dialing back of tariffs across many global economies, including the latest moves between the U.S. and China. Trade tensions have been a persistent cloud over economic forecasts in recent years, so seeing those tariffs rolled back brings welcome relief.
But let’s not get too comfortable. The odds of a recession, while down from earlier spikes, are still hovering above the long-term historical average. Seasoned economists estimate the probability for the U.S. is lower than it was a few months ago, yet still higher than a typical year’s baseline. Globally, risks have also retreated from their highs as trade frictions ease, but uncertainty lingers as economic growth remains uneven from one region to another.
So, what’s the bottom line? Trade policy shifts play a starring role in today’s recession calculus, alongside the usual suspects—corporate earnings, employment figures, and central bank moves. While the economic backdrop has grown somewhat less ominous, market swings and unpredictable headlines can still toss expectations around like a rodeo cowboy on that bucking bronco. Staying diversified keeps you better equipped, no matter which way the economic winds decide to blow.
Is the Bear Market Behind Us? The Elusiveness of Market Bottoms
Much as we’d all appreciate a flashing neon sign that says, “The bear market is over!” the reality is rarely so clear-cut. Bear markets tend to be unpredictable creatures—they rarely move in a tidy, downward line. Even during prolonged slumps, there are often robust rallies that can feel like the worst is behind us, only for volatility to return when least expected.
In fact, it’s virtually impossible to know with certainty whether a recent market recovery marks the true bottom, or if more turbulence lies ahead. Economic downturns and recoveries often reveal themselves only in hindsight, not in real time. As Vanguard and Morningstar analysts regularly point out, even seasoned pros can’t reliably pinpoint when a bear market has ended or spot the exact moment a recession has been avoided.
So, rather than chasing after signals and trendlines, investors are generally better served by staying committed to their long-term plans—including global diversification—regardless of the latest news or market twists.
Understanding the Types of Bear Markets
So, what actually distinguishes the varieties of bear markets you might encounter on your financial journey? Not every downturn is cast from the same mold. In fact, history reveals three general types—each defined by a blend of unique triggers, patterns, and consequences.
Let’s break them down:
Structural Bear Markets: Think of these as the big, bad wolves of the bear market world. These downturns often follow the burst of an unsustainable economic bubble—picture the housing crash of 2008 or Japan’s real estate collapse in the early ’90s. They’re especially severe because they’re usually tangled up with excessive private sector debt. When the bubble finally pops, a chain reaction unfolds: asset prices plummet, debts come due, and industries like banking or real estate can find themselves in the eye of the storm. The result is deep, prolonged pain for markets and economies alike—but, fortunately, structural bears don’t come around all that often.
Cyclical Bear Markets: Unlike their structural cousins, cyclical bear markets are routine passengers on the economic rollercoaster. These occur when the economy cools—recessions loom, and investors start anticipating lower profits and slower activity. The market slides in response, but, with time and the right fiscal or monetary policies (think Federal Reserve rate changes or government spending plans), a recovery generally arrives. They’re unpleasant, but also a natural part of long-term investing.
Event-Driven Bear Markets: Finally, we have those downturns brought on by sudden shocks. Wars, oil crises, pandemics—anything that unexpectedly rocks the system can send markets tumbling. Take the COVID-19 crash of early 2020, or the sharp corrections after geopolitical escalations. These declines might show up quickly and sometimes resolve just as fast, often depending on how rapidly the shock is absorbed or addressed.
Recognizing the distinction between these bear market types helps investors understand that not all downturns spell the same trouble—or require the same response. Staying globally diversified can shield you no matter which bear knocks at your door.
When Bear Markets Aren’t Created Equal
Let’s pull back the curtain and peek at what really happens during different types of bear markets. Not all downturns are cut from the same cloth—some lumber slowly and others dart in and out like startled rabbits.
Think about a structural bear market as the marathon runner of declines. Here, the drop can be steep—sometimes losses of 50–60% spread out over several years. The climb back out? It’s usually a long, steady trek that may take a decade before investors see previous highs again.
In contrast, cyclical and event-driven bear markets move at a brisker tempo. While the decline still stings—typically 25–30%—it usually happens much more quickly. Event-driven downturns, sparked by sudden shocks like a pandemic or a political shake-up, are especially speedy in both decline and recovery, provided the shock doesn’t trigger a deep recession.
The wild card? Recessions. If an initial drop morphs into a broader economic recession, what starts as a brief setback can drag on longer than expected. The lesson for investors: the type of bear market not only affects just how far the market falls, but also how long it takes to bounce back.
Sticking with global diversification ensures you’re not taking bets on which variety of bear might show up next.
Why Knowing Your Bear Makes a Difference
It’s crucial for investors to recognize the type of bear market at hand—not all downturns carry the same bite or behave in quite the same way. Think of it like weather forecasting: you prepare very differently for a gentle rain than you do for a hurricane.
Structural bear markets—the financial equivalents of slow-moving storms—can drag on for years, testing your patience with deep declines and gradual, sometimes decade-long recoveries. On the flip side, cyclical or event-driven bear markets tend to move at a much swifter pace, with rapid declines (often around 25–30%) and equally brisk recoveries once the dust settles.
The key distinction? Whether or not the bad news snowballs into a broader recession. Sometimes, an initial jolt is just a passing storm, but other times, it triggers a chain reaction leading to longer-lasting turbulence.
Understanding which environment you’re in can help set your expectations. It won’t spare you from the market’s ups and downs, but much like a seasoned traveler packing an umbrella or sunscreen, you’ll be better prepared for whatever comes next.
The Three Faces of Bear Markets
Let’s briefly pull back the curtain on bear markets. Not all downturns wear the same mask—these grizzly episodes actually come in three main flavors, each triggered by its own unique set of circumstances.
Structural Bear Markets:
Think of these as the bubonic plague of downturns. Thankfully rare, they arrive on the heels of bursting financial bubbles—often propped up by excessive private sector debt. When the music stops, markets tumble sharply, usually dragging banks or real estate down with them in a cycle of forced debt reduction (deleveraging). The aftermath can be broad and bruising, as seen during the global financial crisis of 2008.
Cyclical Bear Markets:
Picture these as the market’s seasonal flu. They tend to align with the ups and downs of the broader economic cycle. Investors, sensing an approaching recession, pull back, causing prices to slide. Fortunately, they’re not permanent guests—policy changes or signs of recovery eventually help markets regain their footing, restoring some health to your portfolio’s vitals.
Event-Driven Bear Markets:
Finally, there are those sudden stomach-dropping declines sparked by external shocks—a war, a commodity crisis, or, as the world recently experienced, a global pandemic. These downturns hit out of left field, derailing otherwise stable economic trends. Their intensity depends on the scale and duration of the event itself (think the sharp decline in 2020 when COVID-19 took the world by storm).
Understanding that not every bear is built the same can help you keep your cool. Whether the downturn is gradual or dramatic, staying diversified is usually the best way to weather whatever market “wildlife” wanders your way.
Covering the Market
A key reason a globally diversified portfolio helps is because different market components respond differently to price-changing events. When one type of investment may zig due to particular news, another may zag. Instead of trying to move in and out of favored components, remain diversified across a wide variety of them. This increases the odds that, when some of your holdings are underperforming, others will outperform or at least hold their own.
Opportunities Abroad: Europe, Asia, and Beyond
A common misconception is that opportunity lives solely on Wall Street. Yet, if we look beyond our own backyard, we find fertile ground sprouting overseas as well—offering a rich spread of investment potential.
Europe and parts of Asia, for example, currently feature pockets of attractive growth alongside valuations that haven’t soared quite as steeply as those in the US. These regions may incentivize investors through favorable pricing for assets and a burgeoning class of innovative companies—the kind you might spot in a morning Financial Times headline or while sipping espresso in a bustling Parisian café.
Additionally, foreign currencies can play a supporting role. The US dollar, after years of flexing its muscles on the global stage, now appears relatively elevated in value compared to several global counterparts. This can mean that international assets are competitively priced for US investors—and when currencies eventually rebalance, there’s an extra potential kicker in returns.
In summary, by venturing into overseas markets such as Europe and Asia, investors increase their exposure to diverse economies, contrasting business cycles, and different currencies. This globe-trotting approach not only helps uncover hidden gems, but also reinforces your investment “blanket,” further spreading risk and reward.
The results of diversification aren’t perfectly predictable. But it helps create a blanket of coverage for capturing market returns where and when they occur. This goes a long way toward replacing guesswork with a coherent, cost-effective strategy for managing desired outcomes.
Mean Reversion and the Case for Even Broader Diversification
Let’s take a closer look at mean reversion—an age-old concept that’s especially relevant when thinking about diversification. Simply put, mean reversion is the tendency for outliers (those years of especially high profitability in certain market sectors or regions) to eventually drift back toward their long-term average. It’s the market equivalent of what-goes-up-must-come-down—except sometimes, it’s more like what-soars-up-comes-back-to-earth.
For years, certain sectors (technology, we’re looking at you) have delivered standout returns, and the U.S. has headlined the show with steadily rising equity markets. But as these trends mature and valuations become frothier, the likelihood increases that yesterday’s winners might not lead the pack tomorrow. Profit margins that have persisted at unstable highs may cool off, and sectors or regions that lagged could gain their moment in the sun.
Here’s where the magic of diversification gets a fresh jolt of importance. Rather than piling into the latest star performer or hoping lightning strikes twice in the same sector, spreading your investments across different countries, industries, and companies offers a powerful buffer. Maybe European healthcare stumbles just as emerging market manufacturing charges ahead—by holding both, you sidestep the pitfalls of chasing the last big winner and set yourself up to participate in the next rotation.
In essence, the shifting tides brought on by mean reversion remind us of the risks of putting all our eggs in last year’s best basket. Broader diversification means we’re better positioned for whatever the market’s next act has in store.
The Role of the US Dollar in Shaping Global Investment Opportunities
Let’s talk about the shifting tides of the US dollar, and what it means for how you position your global portfolio. For years, the US took center stage—not just for its often-remarkable economic performance, but also thanks to strong investor demand from abroad. This flood of international dollars, eager to capitalize on homegrown tech darlings and robust growth, helped keep the US dollar soaring.
But currencies, like markets themselves, are not static creatures. Recently, the dollar has shown signs of softening. Why might that matter to you as a globally diversified investor?
Investment Incentives Shift: When the US dollar is strong, overseas investors reap even more rewards by investing stateside. Meanwhile, US-based investors considering international equities might hesitate, since currency swings could offset foreign gains.
New Growth Horizons: As the dollar’s dominance cools, other markets—think certain segments of Europe or Asia—are beginning to offer compelling growth paired with lower valuations. This opens the door to a wider array of opportunities as capital starts to flow more freely across borders.
Relative Value Matters: Take a look at the trade-weighted value of the dollar—it has become quite pricey after years of appreciation. In practical terms, this means that both US assets and the dollar itself may have less room for upside compared to select overseas markets and currencies that are coming off more attractive valuations.
Bottom line? Currencies can amplify or dampen investment returns, but they also underline the wisdom of preparing for all eventualities. In a truly diversified portfolio, exposure to various currencies and economies spreads your bets—so you’re poised to benefit when opportunity knocks outside of the US, and protected should the tables turn.
Understanding Bear Markets and Their Recoveries
Market downturns come in many shapes and sizes, but understanding how different bear markets behave can help set realistic expectations for recovery. Not all bear markets are created equal—some are slow burns, while others fall and bounce back with startling speed.
Let’s break it down:
Structural Bear Markets: These are the marathon runners of the market world. Historically, when broad structural cracks appear—think major economic imbalances or crises—stock prices may decline by 50% or more, spread out over several years. Recoveries, too, often stretch out for a decade or longer before markets reach their former highs.
Cyclical Bear Markets: Sitting somewhere in the middle, cyclical bears, often tied to normal economic slowdowns, typically drop around 25–30%. The path back up is faster than structural declines, but still not a quick sprint.
Event-Driven Bear Markets: Here, sudden shocks—like geopolitical upheaval or a pandemic—may drive rapid declines similar in magnitude to cyclical bears. The difference? Recovery tends to be swift, as the markets rebound within months once the event subsides and uncertainty eases.
What’s the wild card? Recessions. Sometimes, what starts as a brief, event-driven downturn can morph into a more persistent slump if it triggers a wider recession. When that happens, patience is key: the market may take significantly longer to right itself.
In short, bear markets each follow their own script, and the pace of the comeback varies. Staying globally diversified means you’re prepared for whichever scene unfolds.
Diversification helps take the guesswork out of investing
The “Crazy Quilt Chart” below is a classic illustration of this concept. After viewing a color-coded layout of which market factors have been the winners and losers in past years, it’s clear there’s never been a consistent pattern.
In other words, if you can predict how each column of best and worst performers will stack up in years to come, your psychic powers are greater than ours. More realistically, it’s best to assume we never know which markets will outperform from year to year.
See additional disclosures below.*
Without a crystal ball, your best bet is to build that encompassing globally diversified portfolio, and stick with it over time. This positions you to capture returns wherever they occur. What does such a portfolio look like? In our last post, we covered how to Diversify Your Investment Universe.
Technology, Globalization, and the Shifting Market Landscape
So, how have technology and globalization shaped profit margins and the broader market ride? Both have played starring roles—sometimes as scene-stealers, sometimes as unexpected plot twists.
For years, globalization broadened the playing field, enabling businesses to tap into new markets, access resources at lower costs, and streamline supply chains across continents. This interconnectedness contributed to rising corporate profits, as companies—from Tesla to Tata—found more efficient ways to operate and compete.
Technology, meanwhile, has acted as the turbocharger. Innovations—think leaps in cloud computing, advancements in automation, and the ongoing AI revolution—have upped productivity, trimmed operational fat, and unlocked new opportunities for growth. The results have rippled through profit margins, boosting market performance and sending tech-heavy indices on quite a run.
That said, these forces aren’t static. The globalization trend faces new hurdles, with shifting trade policies and a growing chorus for local resiliency. In parallel, technology’s fast pace invites fresh competition and hefty reinvestments, especially from the giants pushing new frontiers in artificial intelligence. While today’s major tech players remain profitable and resilient, the landscape can shift rapidly—growth rates may slow, and yesterday’s high-flyers can face new challenges just around the corner.
Through all this, one lesson endures: Diversification across sectors and countries is the best way to weather unpredictable global and technological tides, capturing opportunities wherever they might emerge.
Alpha vs. Beta: A Quick Primer
Let’s talk terminology for a moment, because the investing world is full of words that can feel a bit like secret handshakes (“alpha,” “beta,” anyone?).
“Beta” refers to the return you earn simply by riding along with the markets—think owning a broad stock index fund, like the S&P 500. These strategies aim to capture the general trend of markets over time, which, historically speaking, have tended to climb higher despite the bumps and dips along the way.
“Alpha,” on the other hand, is all about trying to outperform that underlying market trend. It’s what active managers seek by picking specific stocks, timing trades, or using other strategies to uncover opportunities that, ideally, aren’t already reflected in market prices. Rather than hitching a ride on the whole market’s momentum, you’re aiming to beat it—quite a tall order, but one that attracts significant attention.
So, in essence:
Beta strategies are about capturing the market’s overall movement—you get what the market gives.
Alpha strategies are attempts to achieve an extra edge through specialized insights or tactical maneuvers.
Still, as the evidence suggests, consistently finding reliable alpha is rare. Most investors—and their portfolios—are better off relying on broad diversification (beta) rather than trying to outguess the crowd. And as we’ve seen, this diversified approach is the bedrock of successful, evidence-based investing.
Earnings Growth: The Engine Under the Hood
So, how does continued earnings growth keep market valuations humming along? At its core, the market’s current pricing reflects expectations that companies will keep earning more over time. If those earnings dry up, or even just stall out, today’s healthy stock prices could begin to look a bit rich—much like a muscle car running on fumes.
Of course, predicting exactly how company earnings will unfold is no simple feat. Economic cycles play a major part—should a recession hit, earnings may take a hit too. But the plot thickens: big-picture shifts like changing global trade patterns, technological innovation, and increased investment in areas such as artificial intelligence are all moving pieces on the board.
Take recent years, for example. Corporate profit margins have been buoyed by globalization and leaps in technology. Now, though, those tailwinds are facing some pushback. Competition is heating up, technological landscapes are evolving, and established companies are spending more to stay ahead of the curve.
The upshot? While many of today’s leading firms are still posting impressive profits and keeping their balance sheets in tip-top shape, a slowdown in earnings growth could mean markets need to re-evaluate how much those companies are really worth. It’s yet another reminder that the market’s story is always subject to revision—and why a diversified, long-term investment approach continues to be the reliable carriage, rather than the runaway horse.
Your Take-Home
A globally diversified portfolio offers you wide, more manageable exposure to the market’s long-term expected returns, as well as a smoother expected ride along the way. Perhaps most important, it eliminates the need to try to forecast future market movements. This, in turn, helps reduce the nagging self-doubts that throw so many investors off-course.
To see all 10 principles of Evidence-Based Investing at a glance, please visit our Evidence-Based Principles Guide. These principles inform our investing process.
* All rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks, and copyrights related to the Russell Indexes. Dimensional Index data compiled by Dimensional. MSCI data © 2020, all rights reserved. ICE BofA index data © 2020 ICE Data Indices, LLC. Bloomberg Barclays data provided by Bloomberg. FTSE fixed income indices © 2020 FTSE Fixed Income LLC. All rights reserved. See “Index Descriptions” in the appendix for descriptions of Dimensional’s index data. Diversification does not eliminate the risk of market loss. Past performance is not a guarantee of future results. Indices are not available for direct investment. Their performance does not reflect expenses associated with the management of an actual portfolio.