You may have noticed that there has been a touch of market volatility in recent weeks. At times such as these, the shady and esoteric world of stock market investment migrates from the financial press to the mainstream media, and the chief beneficiaries are Robert Peston as he racks up the overtime on 24 hour news, and purveyors of ‘trader-with-head-in-hands’ stock photos.
As is increasingly the case, commentators have struggled to piece together the cause-and-effect going on behind these market movements. The initial trigger appears to have been the collapse of a Chinese equity bubble which looked rampantly speculative all along, combined with the perception taking hold that moves by the Chinese government to devalue its currency constituted panic, leading to the extrapolation of fears about Chinese growth into fears about global growth. Or, perhaps, that Chinese data is even more unreliable than everyone thought, a theory encouraged by the sudden rebounding of the Shanghai Composite Index above the arbitrarily significant 3,000 point mark ahead of a high profile military parade.
So, basically, nobody knows. Short term market data is inherently random and exists beyond any kind of definitive analysis. What the recent sell-off has highlighted, more than anything, is the inability of anyone to predict the chain of events that runs through a shock in one far flung market and, in a world of increasing globalisation and computerised trading, the tumbling dominoes of forced portfolio reorganisation and unwinding of trades everywhere else.
What does this mean for the average investor, if anything? The question I get asked most often when markets are falling is ‘do we change the strategy?’ Which I suppose is a variation of the hoary old stock market question ‘is this time different?’
Except they have different answers. Because although I don’t believe a fundamental change in strategy is in order, it is different. Markets behave differently now from the way they did twenty years ago. And will behave differently in another twenty years. The forces that drive them are not static. The interconnectedness of economies, increasing automation, near instant dissemination of news, the renegotiation of what and who the key drivers are. All these things will continue to shift.
However, I believe this means there is less not more need for a change in core strategy. When you strip out the noise, the only practical response to the increasing uncertainty and inexplicability of short term movements in markets is to hold on to the underlying fundamentals, and control the controllable:
- Markets are unpredictable and it is, in practical terms, impossible to rely on a strategy of benefiting from short term price movements
- Increases in the complexity of global markets and the speed and magnitude of responses to new information are likely to magnify this
- In the long term, markets act to reward such uncertainty. As experienced investors will know, the short term volatility of ‘risk’ assets, such as equities, is the price for accessing incremental returns above those from cash and bonds
- Markets will grow in fits and starts, with large corrections from time to time. They are fundamentally inclined towards bubbles, which ultimately burst
- As such, diversification across asset classes and sectors within asset classes suits most people’s needs better than a highly concentrated portfolio with more pronounced peaks and troughs
- If you hold defensive assets, such as high quality bonds, alongside equities, then actual falls in portfolio values will probably be far less than the falls in particular indexes which grab the headlines.
- A disciplined portfolio strategy which systematically rebalances value between assets on a regular basis will naturally benefit from movements in their relative prices, without requiring any speculation on those movements
- Market commentary can be extremely unhelpful. It is often little more than the post-rationalisation of movements that are little understood, presented as the irrefutable truth. At worst, by being sensationalist in an attempt to sell copy it can encourage investors into irrational decisions (‘buy tech stock’ / ‘markets in meltdown - sell now’)
- It’s important to maintain a sense of perspective and not be tempted to over-extrapolate short term trends. For example, developed world indexes are still significantly up on where they were five years ago, factoring in the recent falls.
In conclusion, the boring answer is probably the right one. If a portfolio is set up based on one’s properly established needs and tolerances, then history tells us that the right course of action is to tune out the noise and stick to the plan, while markets do what markets do. And, try to resist the perfectly understandable - but perfectly wrong - instinct to make changes based on knee-jerk reactions.