The best investment approach for turbulent markets
[Estimated time to read 2.5 minutes]
2016, by any standard, has been challenging for investors. By 11 February, the FTSE 100 had lost more than 12% since the beginning of the year. A week later, markets were back up almost 8%. The Brexit vote caused a significant fall, the FTSE 100 closing at 5982 GBP, yet following a strong rally (having given investors a stomach-churning ride) it's close to flat for the year at 6,657 GBP.This is volatility – it feels random, scary and it can seriously damage your financial health. The see-sawing of markets in response to market news is, at times, unfathomable. Instead of cheering on the low energy prices and their effect on consumers, markets focus instead on the impact of cheap oil on the earnings of oil companies.
The decision last year by the US Federal Reserve, the most important central bank globally, to increase rates in response to an improving economy is seen as a harbinger of doom for emerging markets and the rest of the world. Commentators opine on the imminent end of capitalism and the coming decades of deflation, and the (still unknown) long-term impacts of Brexit. It makes some worry that there is worse to come…
Should you abandon ship?
It's possible that they are all right to be so pessimistic. But before you retreat to your shelter with your shotgun and tinned goods, we think there are a few points to make that investors should weigh up before abandoning their investments, or changing course.
First, many (if not most) of those experts now predicting financial apocalypse were, not so long ago, cheerleaders for markets' ongoing rise. It's striking how frequently we are reminded that most people opining on markets simply don’t know what's about to happen. The reason is obvious: markets are, by definition, driven by the activity of huge numbers of participants and, in aggregate, the market 'crowd' rarely follows the elegant logic of commentators who are paid by the word… and the results regularly confound predictions, that it’s almost surprising that we even care what they think.
Second, it's critical to think about the psychology of markets. We don’t mean the clichéd tension of fear and greed, but something a little more subtle. Commentators often refer to 'risk-on' or 'risk-off' markets: it's shorthand for the prevailing mood and is used to justify the market's response, normally after the fact, to news. In a 'risk-on' world, markets want to go up: every piece of news is interpreted positively. Think of it as optimism on steroids: every piece of data gets the benefit of the doubt and traders pounce on the best interpretation.
'Risk-off' feels so much more bewildering. Lots of analysis, often by psychologists and behavioural economists, shows that markets are inherently optimistic: their natural trend is to go up.
This is why 'risk-off' feels so odd: whatever the news, and wherever it comes from, markets respond by lurching downward. Traders respond by selling, in response to news that a week earlier they would have celebrated.
What about now?
Nobody – and we mean nobody – can predict what will happen next.
But the industry of commentators and experts are paid to speculate, so they spew their guff endlessly and instead of describing the news, they help to shape it and make it.
The equity market response to many events (notably the ECB rate shift early in the year) is comical – first a strong rally, then a sell-off, then a shifty increase - or the polar opposite.
What's the takeaway, the 'so what'?
Just that it is really difficult to keep your head when all about you are losing theirs. The best guide to investing in turbulent markets – and that turbulence is typically a sequence of 'risk on/off' moods – is to have your investment plan written, and to stick to it.
Do not become slave to the fear and greed reflected in this year's market volatility.
"If you can keep your head when all about you..."
"Editor's note: This blog is updated as of 2nd August 2016"