Market waves can pave the way to investing success. Interesting patterns developed in global capital investment markets this week. Reactions and patterns that were familiar, seen many times before when investors get jittery viewing their uncertain portfolio activity. This time the undulating waves of selling and hedging appeared to be primarily caused by the continued uncertainty of oil pricing and production.

On Monday and Tuesday stocks plunged in the US with reaction across global markets, excepting Shanghai markets. Tracking only one index, the Dow Jones Industrial Average (DJIA — the 30 largest stocks in the US by capital) ended high (17,832.99) the day after New Year’s Day and dropped like stones through close of market Tuesday, January 6 to 17,361.64. At market open, the next day swept upward from Wednesday through Thursday. As the article went to press on Thursday night, in a complete reversal, buyers wiped out the loss observed in the first two days of the week with the Dow trading up again to reach 17,907.87.

VIX — the investor fear measurement reflected some of the uncertainty around capital market security value swings that represent close to a 1,000-point arc between the downward / upward recovery during that two-day cycle. Seemingly huge, and not to discount the swift changes in market direction, individual common sense perspective is important, too.

Taken in context, this week’s rapid market movements represented a swing of less than two per cent in US securities’ valuations compared to almost the same drop (508 points) almost 30 years ago. That mega-jolt to the global markets was a 22.6 per cent downward plummet to the DJIA on Black Monday, October 19, 1987 — the worst drop since 1914. I remember that day like it was yesterday. Investors and advisers were stunned.

Still, last week, investors signalled their concerns by selling risk assets and taking strategic moves into hedging positions.

Long bonds (meaning long-term to maturity for return of principal bonds) at the beginning of the week once again provided one hedge strategy against market uncertainty.

The prices of US Treasury bonds (not the interest rate yields which drop when bond prices rise) rose for some longer maturity dates more than 30 per cent over the face value of the bond redemption. For example, a 30-year bond purchased at par a while back for 100 per cent of face value — say $100,000 — was priced at end of day, Tuesday last at $135,000.

If you sold that bond early this week, your profit before US taxes (if you are a US person) would have been significant. Bond traders and bond mutual investment managers will actively trade bonds, if that is the fund’s investment policy.

Individual investors, however, are generally not in trading platforms for bonds; rather low-risk bonds are held for some income, conservative risk smoothing and most important of all, safety for the investor. Could we ever conceive of the US government defaulting on government debt (US Treasuries)?

Security diversification then is key. The net effect on a fully diversified portfolio of stocks and bonds is that these investors will not see the large paper losses (in the aggregate) and have less aggressive paper gains than a 100 per cent stock portfolio. The analogy of a playground swing is pretty apt. Up and down; down and up, always swinging back to the middle (reversion to the mean). Generally, when stocks values surge, bond prices drop. When stock markets slump, bond prices escalate upward.

There is nothing more concerning than a portfolio where every single security value is sky-high; yet, this is often what investors demand. Relatively, you can guess what happens when markets collapse. And that, dear readers, is when security values are at their lowest, that investors succumb to emotion and sell all — at a loss.

Conservative, low-yield, low-risk bonds come often come in for much criticism. Market advisers may advocate “dumping those low-yielding bonds”, because what good are they? In the last 15 years, there have been several major and a few more minor market crashes. Guess what was one of the components that carried the day in a diversified portfolio?

My opinion is that for the ordinary investor, low-risk very high grade bonds are a necessary and justifiable component of a well-researched, well-reasoned broadly asset-allocated and diversified portfolio. Always. Some portfolio managers will disagree, but I make no apologies for being a very conservative international financial planner. Better to have a lower rate of return (and live within your means) than to think you are rich (on paper) with all those high-return investments, only to find out that you will not get back all of your initial cash invested.

This is an old story, but it needs telling and retelling as each new tranche of investors falls to overconfidence in thinking that market investing is easy. Yes, it is when markets only go up, but ...

Emerging market debt (that are also bonds) has been the mantra of investment advisers for years. High yield rates of return, “not that risky,” “should be part of your portfolio”, etc. Yes, maybe, but only in smaller quantities because they do generate higher, sometimes much higher yields. But, the big question always, is will you get your principal back? Think Greece. We discuss those in the next investment segment.

Please never ever forget one very important market rule. High rates of return equal high risk.

This means everything generating high rates of return: stocks, bonds, money market funds, mutual funds, ETFs, commodities, currencies, private equity and any other kinds of securities that are popping just about unbelievable returns — are employing investment strategies that are high risk. Even if it is a real, not a phoney, return — the risk of loss can be exponentially huge.

So, you’ve got a balanced mutual fund in your personal investments (a 50 per cent stocks — 50 per cent bonds) and in your pension? Let’s take a look next week at how they are performing in this market.

Martha Harris Myron CPA CFP JSM Masters of Law: International Tax and Financial Services; on the Professional Tax Advisory Council, American Citizens Abroad, Geneva, Switzerland; president of The Pondstraddler* Life™ Consultancy: international financial planning, publications, presentations for the challenging lifestyles of multinational individuals and their families residing, working, crossing borders, and straddling ponds in the North Atlantic Quadrangle. Specific focus for residents of Bermuda, the premier international finance centre. Contact: martha@pondstraddler.com