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How to deal with market volatility

7th Feb 18 9:38 am

According to AJ Bell

Russ Mould, investment director at AJ Bell reckons after a period of mill pond like calm, volatility surged back into global stock markets over the past few trading days, to test the nerves of investors for the first time since 2015.

He says: “The fact that the global sell off has halted, at least for now, suggests investors have quite sensibly not hit the panic button yet but they will be on high alert and will understandably be monitoring the situation very carefully.  In these circumstances there are five lessons worth remembering, all of which can be useful when it comes to asset allocation, portfolio construction and investment strategy going forward.”

1.     Watch out for cracks in the markets

“Like any structure, markets have their weak points and the pressure begins to tell here first, before it slowly creeps in from the periphery to more core areas.

“And cracks can be seen in certain areas where market action has been particularly speculative – and thus prone to an accident.

  • “Uber had a ‘down-round’. The much-hyped, heavily loss making company raised capital in a private deal which saw its implied valuation fall from $68 billion to $48 billion. Drops of 30 per cent like that aren’t supposed to happen in bull markets to hot-property companies.
  •  “Heavily-indebted companies are coming under pressure. Carillion is a classic example but retailers on both sides of the Atlantic are struggling to service their debts or meet lease payments. Now times are tougher, problems are appearing, as Toys ‘R’ Us, Debenhams and others will attest.
  • “Most spectacularly, Bitcoin buyers have encountered trouble. The cryptocurrency has stuck to the script outlined by market historians who looked at prior market bubbles such as seventeenth-century tulip bulbs and twentieth-century tech stocks. Bitcoin has plunged from $18,000 to $6,200 and the total loss on all 1,500-plus cryptocurrencies listed on www.coinmarket.com has reached over 50 per cent, or $350 billion in 2018 to date.”

2.     Don’t try to time the markets

“Investing is not about timing the market. It is about turning time into money, through the patient harvesting and reinvestment of dividends, which are themselves the result of having identified companies with strong competitive positions, pricing power, good margins, competent management, sound balance sheets and strong cash flow. And the benefits of compounding dividends take a decade and more to really emerge.”

3.     Don’t rely on liquidity

“Stories of US private investors finding themselves unable to trade when they wanted, or at all, on Monday 5 February, were no surprise, as markets can and do seize up when put under duress.

“This is a timely reminder of the dangers of relying on the trappy combination of timing the market and using market liquidity to do so.

“Liquidity is not just being able to buy and sell at the click of a mouse or swipe of a finger. It is about being able to buy or sell what you want, when you want and – most importantly – in the volume you want and at the price you want.

“There will usually be a bid but in a falling market if may be lower than you want or need, so assuming you can always get what you want could prove dangerous.”

4.     If you think this is volatility, you haven’t seen anything yet.

“While Monday’s 1,175-point drop in the Dow Jones Industrials was the biggest fall on record in terms of points, it was nowhere close in percentage terms.

“The US index may have lost ‘just’ 508 points on Black Monday in October 1987 but that equated to a 23 per cent drop. And a mere 38-point plunge on Black Monday in 1929 meant a 13 per cent drop, as part of a crushing string of downward movements which comprised the Crash of that year, so some context must be maintained.

“The US has seen 4 days already in 2018 when the S&P 500 index moved up or down by more than 1 per cent during a trading day. It managed that just 8 times in 2017 but it managed it 137 times in 2008, when the market last crashed – that is more than one such change for every two days.

“As can be seen from the charts below* that compare the number of 1%-plus market moves per month with S&P 500 and FTSE 100 performance, markets do best when they are relatively calm.  However, it is worth noting that extreme volatility can be a buy signal and an increase in volatility in 1998-2000 and 2005-07 did not prevent further gains, although the build-up did herald an eventual smash.

“If history repeats itself then markets could become a lot wilder, even if they could still advance further before they finally hit the wall.”

5.     Check your portfolio and the risks involved, not just the potential rewards

“Legendary investor Warren Buffett uses the dictionary definition of risk, namely “the possibility of harm or injury” and in a financial context this means losing money, your willingness to take that on and ability to withstand it.

“If the market gyrations of earlier in the week made you feel uncomfortable then it is possible you have unwittingly taken more risk in your portfolio than you really feel comfortable with.

“It may be worth sitting down and assess where you do feel comfortable and where you do not, to ensure your portfolio is properly set so that it fits with your overall strategy, target returns, time horizon and appetite for risk.”

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