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Prices slashed – everything must go!

Given the opportunity to acquire something at a discount, most of us can hardly contain ourselves, which explains why hordes of people flood to the Boxing Day sales. Yet faced with falling stockmarkets, many investors exhibit the opposite tendency.

Investment psychology is deeply fascinating. Thousands of highly-complex academic articles have been written about it, but it is hard to get way from the basic analysis that markets are driven by greed and fear.

When stocks are rising, investors are drawn in by the prospect of immediate returns – ‘greed’ may be a harsh word to describe the perfectly reasonable desire to make a profit, yet this motivation does tend to intensify the higher markets rise.

Conversely, when stocks are falling, even when this appears overdone or irrational, it can be nearly impossible to persuade clients that it is the right time to invest. The ‘fear’ of losing money overrides any assessment of value.

Stockmarkets fell sharply last week as investors contemplated weaker global growth, driven by China and the eurozone; geopolitical risks, including the spread of the Ebola virus; and the likelihood (or otherwise) of interest rate rises in the UK and US. Nothing changed significantly from what was already known, but markets can be vulnerable to mood swings.

Low inflation can be good news because it means we will keep growing without interest rates needing to rise. Alternatively, it can be bad news, signalling that growth is slowing and that corporate profits may be at risk. On Friday morning the FTSE 100 was 10% cheaper than four weeks ago, yet investors weren’t rushing to buy as the gloomy narrative held sway.

To some extent, this is irrelevant – it is just ‘spin’, used to explain why stocks are rising or falling, but having no impact on their intrinsic value. However, it can affect the propensity of individual investors to act. When there are a sufficient number of such individuals, the market is driven by the herd mentality. Greed and fear again.

Sir John Templeton, arguably one of the greatest stock pickers of the 20th century, said: “If you want to have a better performance than the crowd, you must do things differently from the crowd.” He advocated buying company shares “at the point of maximum pessimism”, but it takes nerve to buy at this point. Doubt creeps in – what if you’re wrong?

The risk is that by trying to ‘time’ your investment, you miss the big moves. Studies have shown that 80-90% of the return on stocks occurs around 2-7% of the time. Investing is a bit like war: nothing happens most of the time and the biggest danger is boredom. Then all hell breaks lose, but the action is over very quickly.

A study undertaken by Sanford Bernstein, a research firm, covering the period 1926 to 1993 showed that missing the 60 best months in the stock market would have brought down one’s return from 11% to almost zero. Missing out on the big moves makes investing more or less pointless. So it is better to be in the market than on the sidelines.

The key is to be responsible. You should have enough cash or near-cash assets to cover your regular expenditure. Your investment time horizon must also be reasonable. Equities can be volatile, so you have to be prepared to invest over several years to take this into account.

If you have the luxury of time and surplus funds, you can do worse than to follow the advice of the great Warren Buffett: “Whether stocks or socks, I like buying quality merchandise when it is marked down.”

Nick Swales is the Regional Director for Rathbone Investment Management’s Newcastle office. You can contact him on 0191 255 1440 or at nick.swales@rathbones.com

This was posted in Bdaily's Members' News section by Nick Swales .