Market volatility - The bear facts

Tom Stevenson, Fidelity Personal Investing, 21 January 2016

The B-word is back. Yesterday’s sharp fall in global stock markets took important markets like Japan and the UK into bear-market territory. This correction can no longer be dismissed as just a wobble in China’s notoriously volatile A-share market.

There is no official definition of a bear market – the term for a persistent and significant fall in asset prices. But the closest we have to an accepted measure is a 20% slide in prices. In London and Tokyo that’s what we suffered on Wednesday.

No-one will pretend that a fall of this magnitude (in just nine months in the case of the UK market, less than six months in Japan) is much fun. When sentiment turns in this way there is generally nowhere to hide and shares have fallen across the board.

However, it is important to realise that this is normal service for stock market investors. Volatility is the price that we pay for the long-term outperformance of equities compared to other assets like bonds and cash. If you do not have the stomach for these kinds of ups and downs – or your financial needs are so short-term that you do not have the luxury of riding out the storm – then the stock market is not the right home for your money.

I was asked this morning on the BBC if bear markets were a bad thing. It was a good question which I answered by saying that they are neither good nor bad but simply how markets work. Stock markets oscillate around fair value, overshooting in both directions. We just have to get used to these swings.

I also pointed out that when we look back at this particular episode in 20 years’ time, it will almost certainly be indistinguishable on a chart of the FTSE 100 index. If you try to identify the 1987 stock market crash on a chart – I remember well that it felt like the end of the world at the time – it is now almost imperceptible. In the context of the growth of stock markets over long periods, these short-term wobbles are like ripples on the surface of the ocean.

What short-term corrections do provide, however, is the opportunity to top up portfolios at more attractive prices. The principal determinant of long-term returns from investment is the entry price. If an index is valued at 400, for example, a buy price of 80 means a return of 400% compared with a 300% return at a buy price of 100. A 20% decline can massively enhance your long-term returns if you have the courage and cool-headedness to take advantage of it.

The best way to achieve this is to take the emotion out of investing by automating it. Set up a regular savings plan that drips your money into the market on a regular basis without any intervention from you and you will ensure that your money is put to work when it feels most uncomfortable. That, by the very nature of markets, will be the time that the potential returns are the highest.

Of course, there are no guarantees in investment. It is entirely possible that share prices will fall further from here. No-one knows. What we do know with certainty, however, is that the most successful investors are those contrarians who are capable of holding their nerve when all around them are losing their heads. Investing is simple but by no means easy.

What is also worth remembering at times like these is that not all assets move in tandem. As investors lose their appetite for risk they look to park their money in safe havens. The prices of better-quality government bonds, for example, have risen as share prices have fallen. This makes a strong case for a balanced portfolio, spread between uncorrelated assets.

Timing market movements at times of extreme volatility like this is a fool’s errand. Not only is it impossible to catch the tops and bottoms of market moves, it is impossible not to be caught out by powerful counter-moves against the prevailing trend. It may not happen today or tomorrow but at some point soon there will almost certainly be a dramatic reversal of yesterday’s big fall. Our research shows that missing just a handful of these best days in the market can seriously compromise your long-term returns. If you are out of the market when one of those sharp rallies take place you will never be able to capture it again. It’s gone.

So, hard as it feels to do so, the best guidance I can give to investors at times like this is to stop watching the screen, remind yourself why you are investing and focus on your long-term goals not the short-term noise. This too will pass.

Important information

The value of investments and the income from them can go down as well as up and investors may not get back the amount invested. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. Investments in small and emerging markets can be more volatile than those in other overseas markets. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Fidelity Personal Investing does not give investment advice. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.

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