Investment Insights | Considerations during equity market falls
Significant equity market falls are in the headlines again. Amid a backdrop of worse than expected economic data coming out of China and continued fears over Greece, the Standard and Poors (S & P) 500 Index in the US fell 3.2% on Friday and is 7% lower for the month. As per usual, there was a domino effect across the UK (down 2.8% for the day and 6% for the month) and Hong Kong where the index dropped 1.5% for the day in a month during which the Hang Seng Index is down a massive 12.2%.
Clearly we have seen some large falls and for these reasons we are all likely to be exposed to a media overload of what it all means to us investors. There will be the doom and gloom approach of those commentators dusting off their coats and saying words to the effect of “I told you so” and “I have long predicted this”.
Be that as it may, if we can offer you some things to consider at times like this:
1. Don’t panic
Panic is self-defeating, because when we shift into a state of panic, our vision narrows – literally and figuratively. We think small instead of expansively in a way that would actually ensure our long-term well-being. To panic about your financial plan is clearly not a sound course of action.
2. Your asset allocation is the key driver to returns
A number of academic studies highlight that it is your asset allocation, not market timing or stock picking which predominantly drives returns. So, if your risk appetite or longer term objectives have not changed then there is probably very little to do at this time.
Changing your asset allocation should never be a reaction to a changing market value (up or down), but rather a response to a change in your time horizon and / or risk appetite.
3. Re-confirm your time horizon
Short term market swings are common, but what is the target time frame for you and your investments, or the income it can deliver? If it is beyond 5 years, and / or you are in the accumulation phase, then there is possibly no change required at the moment. If you are undertaking a regular investment strategy in times where the market is falling, then you will essentially be acquiring more assets at lower unit prices over time. – That’s a good thing!
4. Remember that risk has a downside
The Global Financial Crisis of 2008 caused people to fully understand that risk has a downside which needs to be taken into account for every decision that we make, financially and personally on behalf of our loved ones.
5. Bear market characteristics
We are not necessarily in a ‘bear market’ but if we proceed down that path, remember that:
- Bear markets are an organic, natural, constant element of a never-ending cycle. The capital markets are capable of perfectly psychotic behaviour constrained only by their capacity for emotional excess in the relatively short term (a year or two; rarely more). In the intermediate to longer term, capital markets in general and the equity market in particular are powerless to do anything but reflect the underlying economic fundamentals.
- Bear markets are as common as dirt. If we define a bear market as a decline in the broad market of about 20% on a closing basis, then we have had 14 since World War II. As their beginnings and endings are virtually impossible to time, it is important to develop the emotional maturity and financial discipline to remain invested and patient through them.
- The great volatility of equity markets is the reason for, and the driver of, their premium returns. “Volatility” does not, mean “down a lot in a hurry.” Nearly four years in five, equities go up a lot and quite often in a hurry, but journalists somehow never characterise such markets as “volatile.”
Rather, volatility refers to the extreme unpredictability, both up and down of equity returns in the short term.
Equities are volatile. You just never know what they are going to do from one period to the next. And the premium returns of equities are an efficient market’s way of pricing in that ambiguity. There are no ‘good markets’ and ‘bad markets;’ there is just one supremely efficient market. And its way of dealing with equity volatility is to demand, and obtain returns which have nominally been about twice those of bonds and, net of inflation, real equity returns that are nearly three times greater.
Premium equity volatility and premium equity returns are thus two sides of the same coin. So, in moments of stress such as the current environment, don’t wish away the volatility of equities, because you are, whether you realise it or not, wishing away the returns.
- A bear market is always, repeat, always the temporary interruption of a permanent uptrend. In the history of all market declines, both large and small, through all of the bear markets of the past, we need to remember that the advance is permanent and the declines are temporary. Always.
Written by Lex Goldsmith | Senior Advisor | Principal Edge Financial Services | 24th August 2015
