Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

This article first appeared in the Telegraph

INVESTORS reacted to the emergence of the Omicron variant as they always do when confronted with potentially bad but unquantifiable news. They assumed the worst. The timing of the announcement ensured that London bore the brunt, falling more than 3% at the end of last week. Wall Street took the view, as it does, that this was largely someone else’s problem - and anyway we’re on holiday.

Also par for the course, was the counter move after a weekend away from the screens. Markets rallied, albeit by rather less than they had fallen the previous Friday. The nature of modern markets, driven by risk management algorithms and programme trading, is that the computers shoot first and ask questions later. Volatility has become an either/or thing - mill pond or mid-Atlantic storm with not much in between.

The reality is that the scientists still know very little about the latest coronavirus mutation and investors naturally understand a lot less. The range of possible outcomes is wide, from not very transmissible with only mild infection to vaccine-dodging new killer bug that sets us back to square one. Judging where we lie on that spectrum will remain pure speculation for at least the next few weeks.

Of course, we have been here before. And the playbook is similar. In the summer when the Delta variant arrived, markets briefly took fright, even if you would be hard pressed to see that wobble on a chart. We are hard-wired to act when confronted by danger. The fight or flight response won’t allow us to lean back and see how things unfold. As they say, and we prefer not to hear: don’t just do something, sit there.

Uncertainty goes with the territory for investors. Which is perhaps why we spend so much time and effort trying to overcome it by forecasting the future. I was reminded of this by a rather good book I read recently called Seven Mistakes Every Investor Makes by Joachim Klement. Attempting to divine the future is number one on his list of common errors.

I’m not unaware of the irony of what I’ve just written, a week on from offering my thoughts on what 2022 might hold in store. Let’s just say that goes with my territory. Klement points to the folly of market predictions by noting that a poll of strategists quoted in the FT at the beginning of 2019 suggested a 17.5% rally in the S&P 500 that year, an average struck from a wide range of forecasts from a fall of 10% to a rise of more than 20%. The median in this case was a spuriously precise and totally meaningless number.

Financial forecasts are usually wrong, not just in scale but also direction. In fact, according to Klement’s book, in 13 of the past 20 years strategists have been wrong by more than 10 percentage points while they correctly picked the direction of travel of the market in just nine out of 20 years. That is a fraction worse than flipping a coin.

In another study, the predictions of market experts were a little less accurate than simply assuming that the market will be exactly where it is today in a year’s time. This is true whether you are talking about stock markets or interest rates. Work on the basis that either of these will be where they are today and more often than not you will be right.

An interesting aspect of investment uncertainty is that, contrary to popular belief, it doesn’t reduce as the time horizon lengthens. It’s often pointed out that the longer you hold an equity investment the more likely it is to outperform one in bonds or cash. This is true because for longer periods the range of possible returns narrows and gravitates towards the long-term average, which is higher for shares than other investments.

But this doesn’t mean that there is more certainty about the number that really matters to an investor, how much their portfolio will be worth at a given point in the future. The reason for this is compound interest. Even a relatively minor difference in return year by year can add up to a yawning gap between best- and worst-case outcomes over, say, 15 or 20 years.

Faced with this uncertainty, the natural reaction is to try to gather more information to improve the odds of making a better forecast. Again, this is a fool’s errand because access to lots of facts and figures simply makes us more confident without actually delivering an improvement in accuracy. Professionals, who are sniffy about the rules of thumb that lay investors rely on and who are confident that they alone understand the maths, are particularly prone to this.

Looping back to where we started, with a hugely uncertain development in the still unfolding pandemic, how should investors really be responding this week? I’d say humility and healthy scepticism would be a good starting point. If we focus on what we know rather than what we hope or think we are more likely to make sensible judgements.

We know that vaccines were developed rapidly that reduced transmission, infection, hospitalisation and death from the original virus and its early mutations. I suspect that science will prevail again in due course. We know that an initial economic hit was quickly reversed. We know that the pandemic creates both winners and losers. And we know that monetary and fiscal policy is responsive to changes in the Covid situation.

This means that last week’s drop was most likely an over-reaction but that markets will be more volatile for the foreseeable future. Investors initially assumed the worst. They should also hope for the best. And they should position themselves for the likelihood that we end up somewhere in the middle.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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