Former Federal Reserve Chairman Alan Greenspan was once coined the “maestro.” That’s partly because of his mastery at orchestrating his message to the markets.

But perhaps it’s time for Greenspan to hand this baton to current Chairman Jerome Powell.

Going into his highly anticipated Jackson Hole address, it sure seemed like Powell would disappoint at least one corner of the stock market.

But instead, Powell’s well-executed address managed to see interest rates remain stable while a broad stock advance unfolded (which I discussed in Your Money Matters this week).

A true maestro at work!

But there’s something else that Greenspan and Powell have in common. They’ve both helmed the Federal Reserve at a time when stocks are behaving in bizarre ways.

Just as Greenspan experienced during the dot-com bubble, something is broken in the stock market this year. Let me share a couple of charts to show you what I mean…

Something’s Not Right

Several factors are driving huge dislocations in the stock market. Fed policies are just one factor at work, which Ted wrote about yesterday.

Investor nerves and knee-jerk reactions to the ongoing pandemic are causing bizarre price swings as well.

We haven’t seen this type of stock movement since the dot-com bubble. Let me give you some examples:

  1. While the S&P 500 Index has now gone 10 months without even a 5% pullback, the average drawdown in small-cap stocks has entered bear market territory. The chart below shows that the average drawdown across small caps hit nearly 24% despite the S&P 500 marching out to new all-time highs.

(Click here to view larger image.)

  1. Stocks in different sectors are experiencing unusual price swings. Just look at the correlation below between a growth and value exchange-traded fund going back 25 years. The correlation in the bottom panel typically stays between 0.8 and 1.0. That means growth and value stocks tend to rise and fall together. But this year, the correlation has plunged to levels last seen in the dot-com bubble. That means stocks aren’t moving in tandem, and instead, are all over the place.

(Click here to view larger image.)

In this environment, it’s frustrating to figure out where the next set of winners will emerge. But before you give up on trying to get ahead, let me show you a strategy to prosper.

The Right Way to Diversify

This year, the stock market is highlighting the importance of diversification.

The conventional wisdom is to not place all your eggs in one basket. Spread your bets around different stocks, across different sectors, so one bad call doesn’t wreck your portfolio.

That’s good advice, but there’s another critical angle: diversifying your investment strategy.

I’m talking about being strategic as well as tactical. Strategic investing is your long-term game plan, while tactical investing takes advantage of short-term opportunities.

For those areas of the stock market that have seen sharp pullbacks this year, that creates tremendous buying opportunities for your strategic portfolio. Many companies are trading well below their fundamentals and their long-term growth potential.

Meanwhile, the sharp rotation taking place across sectors is a ripe environment for tactical trading. That’s why your portfolio should be diversified across both types of strategies.

And if you need help figuring out how to combine and deploy those strategies, be sure to check out everything under the Bauman umbrella. You will find strategic and tactical opportunities across The Bauman Letter, Profit Switch and Flashpoint Fortunes to create a truly diversified portfolio that can thrive in these out-of-whack markets!

Best regards,

Clint Lee
Research Analyst, The Bauman Letter