What Should You Do When Markets are Manic?
“In many ways, the stock market is like the weather in that if you don’t like the current conditions all you have to do is wait a while” – (Lou Simpson)
Earlier this year, stock markets around the world were hitting new record highs. In February, however, some of the stocks that had been leading these gains dropped sharply.
Tesla, for instance, lost 28% in just over four weeks.
There has also been a lot of unusual activity, such as what happened with GameStop. A social media army pushed up the price of this gaming retailer, only to see it crash back down again, then up again, then down again.
This was an extreme case, but it got a lot of media attention. That is because when individual investors get this involved in the stock market, it is often a sign that that the usual rules that govern share prices have gone out of the window.
Back to fundamentals
Ben Johnson, a director at Morningstar, noted recently that it looks like the market has lost touch with the fundamentals that usually matter.
Put another way, many stocks have been making big gains because more people have been buying them. And more people have been buying them because they have been making big gains.
It has become difficult to know what many of these shares are actually worth, because some investors seem willing to buy them at any price. However, this never lasts.
Johnson put it like this:
“One theory as to why trees don’t grow to the sky suggests that gravity is the limiting factor. The taller trees grow, the harder they have to work to overcome gravity to pull water through their roots and distribute it to their extremities.
“Gravity has a similar effect in stock markets, though it goes by another name: fundamentals. Economic growth, earnings growth, inflation – these are the fundamental forces that shape markets. Markets will often defy fundamentals during shorter time frames, but over the long term there is no escaping them.”
How does this end?
So, what does this mean? Is another big crash inevitable? Has one already started? Would it be better to take out your money and wait for things to settle down?
That might sound like a good idea, but timing the market always needs two decisions. For the decision to get out now to ultimately be a good one, you also have to make a second decision: you need to know when to get back in again.
That is far more difficult to do. When markets fall, there is no way of knowing when they have hit the bottom.
The second problem with trying to protect yourself by getting out of the market is that this can only ever be a short-term solution. For most of us, investing in shares is still likely to be the best way to grow your wealth over the long term.
There have been many crashes over the past century, and some of them have been long, and severe. Yet the stock market has outperformed all other asset classes over that period.
Assess your portfolio
That is why the best advice to investors when the market seems to be behaving irrationally, whether it is going up or down, is usually to do nothing. If you can sit out the swings in the short-term, you will benefit in the long term.
However, as Morningstar’s Johnson notes, sometimes you can also take the chance in times like this to think a little more about your portfolio:
“I don’t think investors should try to time the market,” he wrote. “I do suggest that now is a good time to take a close look at your portfolio and ask some simple questions.
“Are you comfortable with your asset allocation? After markets bounced back, stocks might represent a bigger piece of your portfolio. This might be an opportune time to rebalance.”
But don’t get carried away.
“Once you’ve reacquainted yourself with your portfolio and gotten comfortable with your asset allocations, your best bet is probably to walk away from it for a while,” wrote Johnson. “Late Vanguard founder Jack Bogle said: ‘The stock market is a giant distraction from the business of investing’. These words have never rung truer.”
To discuss your portfolio and how it is currently invested, speak to your financial adviser.
Provided by Vaal Triangle Insurance
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