The stock market uptick in July and early August led financial experts to question whether we’ve entered a new bull market or are experiencing a bear market bounce.

Differences in opinion are rife, which is why we’re seeing experts employ a variety of graphs to match what’s happening in the current cycle with past cycles to reinforce their point of view.

The charts circulating in the media look something like this.

There are multiple problems with charts such as these. For a start, they place too much emphasis on backward-looking definitions of market cycles. And crucially, they don’t reflect current sentiment in predicting what will happen in the future.

When analysing financial data, it’s crucial to bear in mind that you can “torture statistics” to say whatever you want them to. For example, you can easily find data to support your preconceived ideas or manipulate starting dates, periods, and benchmarks to achieve the result you’re looking for.

In reality, much as studying the past can be a useful exercise, a more important source of information is what’s happening in the present. And it’s clear that what’s affecting the market most in the current environment is inflation and the market’s response to soaring prices.

Several unique factors are at work, all of which have played a part in rising inflation. Events including the war in Ukraine, and the ongoing pandemic supply chain issues have contributed to the rise in prices. As has the government’s financial support during the pandemic, which stoked consumer spending.

The problem we have now is that if inflation remains high, interest rates will continue to rise. And if interest rates continue to rise, the value of stocks will keep dropping.

However, the gains seen in the States in July have amped up the discussion as to whether inflation may have reached its peak. If inflation has indeed peaked or is close to it, then stocks will start to rise again. However, making predictions is always tricky, even in a more stable market environment.

An approach that has delivered long-term results is to move away from looking for answers in historical charts, consider current economic factors and policy actions, and focus on diversifying your portfolio instead.

We can only ever speculate on what will happen with stocks in the short term, which is why Clearwater’s strategy is to focus on investments that are more likely to perform well in the long term.

Many people invest to make quick profits on the share market, but this approach is riskier now than ever. Alternatively, investing in a diversified portfolio can deliver benefits during times of uncertainty, even if returns are slower and steadier.

If you think about it, it makes perfect sense. If your portfolio is formed of an assortment of different investments, when the share market drops, most stocks will drop but not by the same amount. Importantly, other asset classes may not fall as much or not fall at all.

In fact, market drops can lead to smart buying opportunities. Most companies get hit, even the good ones, making it the ideal time to invest in the more promising businesses and assets. This is why investing in a well-diversified portfolio is key. Of course, there will always be winners and losers, but the aim is to spread risk and minimise losses.

Maybe we’re nearing the end of this cycle, maybe not. But by diversifying our investments, you can limit your losses and capture enough upside in the good times to end up with strong long-term returns.

by Gary Lucas.

Diversification. A smart long-term approach.