How should we respond in periods of significant market volatility?
(which gives rise to a different discussion from the question: How do we respond in such periods?)
Investor Panic and Fear creates opportunity!
The moral of the investment story is to apply strategy for the available, considered timeframe. Responses to market volatility are as diverse as the people who participate in the markets – investors and traders alike. Our firm view, is that investors gain when investor sentiment driven by strategy constrains spontaneous reaction – by strategic consideration of all relevant factors: financial circumstance, risk tolerance, goals and time constraints.
Avoid being ‘a victim’
It is not helpful to play ‘the blame game’ – focusing on the failure of regulators; or on the greed of executives of free-wheeling financial institutions (that have in times past, resulted in an untrammeled expansion of debt); or on the unidentified ‘they’ who ‘should have known better’ or ‘should have warned us’ – but whilst dwelling on those matters for the moment you can count on there being further regulation in the wake of each period of economic failure or market disruption. (As a consequence of the GFC, the ratings agencies engaged by financial institutions to give their products an investment/ credit rating suffered a considerable loss of credibility.)
Most ‘investors’ react to market and economic circumstances: in the early stages following the onset of the GFC investors, both personal and institutional, undertook a massive deleveraging process (which caused risk assets1 to be re-priced). Investors who don’t consult with a professional financial planner can fall into the trap of blindly selling their ‘risk assets’, which unfortunately locks in their losses for all time.
Understand the investment markets and economic fundamentals
As a consequence of this immediate post-GFC process long-term damage was inflicted on the real economy. As consumer spending contracted, corporate profits in general retreated and those companies, particularly smaller ones, that were over-leveraged (they had borrowed more than their new circumstances could comfortably service), failed as Banks and other financial institutions dealt with the credit crunch that ensued. Though Governments gave support those institutions that form the financial superstructure of a modern economy, their shareholders bore a heavy burden via equity dilution – and reduced dividends.
We alerted our readers when we first published this article (in October 2008), to not expect a swift recovery; and over the coming months to brace for the deluge of bad news relating to the economy with accompanying remedial steps proposed by Governments. We also gave alert to the effect that: ‘Companies will generate their own share of misery and hedge funds, private equity, investment banks and the like will lose their following. Chronic earnings downgrades and the impression that we are on an endless treadmill will damage the cult of equity.’
In the original form of this post in October 2008, we said – ‘On account of the likely response by Governments which will include much reduced interest rates, we might expect the increase in the monetary base to be ultimately inflationary. In such an environment equities will seem a great deal more attractive than cash.’. Now, five years on, we are yet to experience the inflation but we are certainly in a situation where the market participants (investors, both long-term and speculative ) are voting with their feet and buying equities: and most of the Western World share market indices are at or near record highs.
Pursue strategic investment opportunities
Earlier in this article we referenced investors who don’t consult financial planners for professional advice. One of the advantages gained by ‘advised investors
‘ is that they develop an understanding of their financial needs in wealth management terms and are guided by professional, personalised advice that is a documented investment strategy that becomes their ‘road map’ to attainment of those goals.
To the extent that their asset allocation is diversified, their investment in equities is implemented acknowledging the investment cycle that persists in respect of all asset classes: as investors sell out of shares (driving their prices down), they increase their allocation to assets with more stable pricing. In the aftermath of the 2008 GFC, many went to Cash and/ or high-security bonds with the consequence that the cost of bonds increased, reducing their yield to investors
Over the couple of years since late-2011, the wheel has been turning, the cycle of investment allocation preferences stays in effect – and now shares are being sought by investors because they are generating a higher yield than bonds (and the share-price volatility has diminished considerably).
Whilst we acknowledge that periods of high volatility in markets do not paint a pretty picture, it is also recognised that the markets are anticipatory mechanisms. The share price of even good companies with low financial risk get pummeled in such environments – they tend to be dumped along with the bad. Where share price volatility is caused by an impending recession sharemarkets will price in the anticipated fall in revenues. Whilst actual dividends may reduce, the better companies should be able to provide reasonably consistent yields.
The reaction to these market conditions is usually a period of over-selling: that is prices reflect a worse situation than actually exists – and for the long-term investor this could be a buying opportunity (provided they acquire stocks/ assets that are within criteria set out in their strategic plan).
Wealth accumulation in times of Fear and Panic
The obvious conclusions that investors can draw from the lessons of recent market downturns are:
- always work to a professional, personalised strategic plan;
- consider being contrarian when making investments;
- investment cycles live on; and
- the old adage applies: There is light at the end of the tunnel!
The experienced advisers at Continuum Financial Planners Pty Ltd work to pursue the best interest of their clients: ‘we listen, we understand; and we have solutions’ that we reveal in personalised, professional wealth management advice. To find out how you can benefit from engaging our services, call 07-34213456, or use the website Contact Us page to set up a meeting with one of our advisers.
1 Risk assets can be considered to be investment assets that provide growth (and often a source of some income) that can vary with changing economic or market circumstances. Shares in publicly-listed companies; and property fall into this category, along with a range of other investment assets.
(Updated, re-posted November 2013. Refreshed and reposted October 2017)
Other related posts you may like to read: