by Alexander Beard, on Feb 11, 2016 10:56:34 AM
Stock markets have been stormy of late, with relatively large changes in values on a daily basis. At the time of writing we have seen three consecutive days of falls. The headlines are all about market falls, but what is really going on?
The real answer, is that nobody knows for sure. When you look at charts of investment returns in the past it is easy to identify turning points, or link market movements to specific events. But when you are living through the market movements it is impossible to see what will happen the next day. To make a nautical comparison, it is like sailing through stormy seas. When you are at the bottom of the wave, you cannot see beyond it – there may be calmer waters on the other side, or even bigger waves to come.
In the investment world, we can only use the information that is currently available to try and make sense of things. We can look behind with certainty, but the future is unknown. The key information available at the moment is:
- Chinese growth is slowing (but it is still positive).
- Oil prices and other commodities (e.g. copper, steel etc) have fallen sharply in response.
- This has hit the value of many mining and oil companies.
- This in turn has hurt banks because some oil producing firms are heavily indebted and may not be able to repay the bank.
- This factor is also disturbing high yield bond markets.
- Unemployment rates are falling in the US and the UK.
- Central banks in Japan and Europe are cutting interest rates, a process that helped drive the US economy towards growth in recent years.
- The rate of economic growth in India is starting to outstrip China (a new source of demand for commodities perhaps?)
- Low oil prices tend to boost consumer spending.
- The US Federal Reserve has said it is now unlikely to raise interest rates this year, to support the US economy.
This final point about the US Federal Reserve is an interesting one, and a good demonstration of what I believe is happening currently. It can be interpreted both ways. Last year, a similar announcement drove markets higher because of it shows support for the economy, this year the reverse has happened because markets have interpreted it as evidence of a struggling economy in need of support.
The stormy waves that we are dealing with currently seem to be more driven by how people feel about new information, rather than reacting in a more rational way. In other words, a good portion of the volatility is driven by sentiment, a force that should not be underestimated, even if most evidence points to a stronger global economy.
At times like these it is important to stick to the key rules of investing:
- Take a longer term view (5+ years), attempting to avoid the downside mostly leads to missing the key part of the subsequent upside. Investing is a long term game and very likely to pay off in the long run.
- Keep cash reserves so that you are never forced to sell at a bad time.
- Diversify – remember, some assets (such as Government Bonds) tend to rise when stock markets fall.
These key rules should help you weather any storm. If you have any concerns at all please do contact your adviser.
(Please remember investments can fall in value as well as rise, so you could get back less than you invest.)