Has the investing penny dropped?

Andrew Wilson

In trying to make sense of it all the brutal market volatility and sector rotation, many investors will have been left asking – just what is going on in the markets?

When it comes to equities, it is clear, albeit with hindsight, that investors were too quick in the post 2009 bull market to bid up shares to fancy valuations.

That is, markets anticipated a recovery in earnings and revenues which was very slow to arrive, and, other than in the US, hasn’t really arrived at all. This has led to previous equity valuations to now look fanciful, as the anticipated growth just hasn’t materialised.

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Belatedly, the penny has now dropped that instead we have sub trend growth (or rather trend growth is far below what market participants had assumed it would be), and a series of unimpressive mini cycles rather than a self-sustaining recovery.

So what should investors do?

Warren Buffett likes to compare behaviour in the stock market to that in a shop ‘sale’. When goods are on sale, you tend to buy more of them, but when stocks are on sale (falling prices), investors tend to panic and do the opposite.

The reality is with every market fall in price, your future expected return goes up. And yet, investors are more likely to want to buy a declining future expected return, and sell (give up their rights) to a future expected return that has increased.

Psychologically speaking, when stressed out (and feeling an existential threat) we have least tolerance for ambiguity, and instead have a huge desire for ‘closure.’ In short, investors often grab for the ejector button while shouting ‘Get me out!’.

Despite this, and the desire to hit the ejector button, it’s worth remembering that markets spend more time overshooting in one direction or the other than they do at a notional fair value or in line with their long term trend.

For example, I like to think of our clients’ portfolios moving towards their destination in a wave. This is the mechanism by which the bottle arrives on the beach, having bobbed up and down an awful lot along the way.

So, the more often a client looks at their portfolio, the higher the chance that it is away from its fair value or trend and moving further out, and temporarily moving towards the peak or trough of the wave.

That snapshot is therefore not a very true picture of the aggregate situation, and is certainly not likely to be comforting, or at least likely to seem at odds with their financial plan.

The start of 2016 has been another reminder of why investing should be done with a long-term view, as well as diversification. Ultimately, market volatility should not be seen as a reason for pessimism – it is unavoidable.