As major economies including the US, China and the UK are showing positive signs of recovery from the Covid-19 pandemic it may be tempting for investors to breathe a sigh of relief, but recent events have shown that it may be too soon to assume smooth sailing from here on.
Navigating volatile markets
The blockage of the Suez Canal by the huge container ship “Ever Given” and the sudden fire sale of stocks by American hedge fund Archegos Capital have provided a useful reminder that significant events can come out of the blue. Few predicted a global pandemic last year and the same can be said of the banking crisis in 2008/2009.
I expect many of us have looked at long-term charts of the FTSE 100 or S&P 500 indices and thought “If only I’d bought at (low) point x and sold at (high) point y”. It’s understandable but, of course, rather a futile exercise. That’s because the chart is historic and looks backwards which means it is of little use to investors looking to invest now and there are many variables which influence the market at any one time.
There have been some exceptional moments when extreme market moves have made it very tempting to follow the herd into buying or selling – for example buying during the dotcom bubble in 1999/2000 and selling as stocks plummeted in the financial crash in 2008/2009.
Many investors don’t see the dangers of a long bull market and persuade themselves that “this time it’s different”. That was certainly the case during the dotcom bubble, but it certainly wasn’t the first time that had happened. Previous examples go back as far as the tulip bubble in the Netherlands in the c17th.
When it comes to shares its worth remembering that market indices are calculated using share prices, whereas what really matters is the valuation of individual companies implied by their share price. That is what large, long-term institutional investors, such as pension funds and insurance companies, tend to focus on because they know that a rise in share prices does not, by itself, mean that companies are overvalued. They use a range of measures including the price/earnings and enterprise value/ebitda* ratios, to determine value. (*Usually calculated by adding a company’s market capitalisation, debt, any minority interest and preferred stock together and taking away cash. ebitda – earnings before interest, tax, depreciation and amortisation)
For long-term investors willing to accept that investing in shares inherently carries risk, a little short-term volatility is nothing to get too concerned about. It's simply the nature of investing in shares. However, there are some strategies that can help. Investing by drip-feeding steadily into the market over time is one. When it comes to selling there’s no harm in following the old adage of running winners and cutting losers. That’s quite a rough and ready approach so it's worth also considering other factors, such as the chances of a rise in interest rates and prospects for the economy.
As the US markets have soared to record highs in recent times the value of stocks has increasingly become a focal point for investors. More economic stimulus measures have been approved by Congress and the gradual easing of Covid-related restrictions may lead investors to believe that the good times for shares will simply go on and on. But history tells us that bull markets don’t go on forever and could come to a halt if bond yields rise and inflation looks like becoming a problem.
All information given including prices, yields and our opinion is correct at the time of publication. Our opinions on investments can change at any time and for our latest view please go to www.share.com. To understand how our Investment research team arrive at their views please read our Investment Research Policy.