We want to take a moment to update you on our thoughts related to the recent world events, their impact on the wider financial markets, and, ultimately, on your personal financial situation. We’re sharing this article written by a respected peer of ours at Willow, Dan Haylett of TFP (with his express permission).
Firstly, we want to say that we completely understand if you have been concerned by the constant barrage of media reporting on global stock market falls, for whatever reasons have caused this to happen.
We have been here before and, even though all the academic research and evidence confirms that we must stay disciplined in our investment approach to get the best possible outcome, we fully understand the temptation to take a look at the valuation of your investments! It’s something we all do.
But, we need to constantly remind ourselves that we can’t control the financial markets. We also need to remember that this is okay.
Markets are driven by news, and we simply don’t know what will happen in the weeks and months ahead, whether it’s the spread of the coronavirus, its impact on the global economy, the oil price, Brexit or something else entirely.
But please don’t despair. There’s also much that we can control, including how much we save and spend, the amount of investment risk we take, how much we pay in investment costs, our portfolio’s tax efficiency and, most critically at a time like this, our own emotional reaction to the market ups and downs.
Indeed, if we were going to design an experiment to test investor behaviour, this past month would provide a nearly perfect template. Think about it. We have a virus without a vaccine that’s spreading rapidly, but nobody knows how rapidly, and is damaging the global economy. But nobody knows how badly and this has come at a time when many investors were already anxious after an extraordinarily long market run of positive returns. On top of that we then see the oil price drop by around 25% which further spooked the market, investors and the public alike.
Going into this New Year, many stock markets around the world were trading near all-time highs including major indexes in the US, Canada, UK, and Australia. In fact, since the end of The Great Recession in 2009, many stock markets around the world have seen a doubling or tripling in price. In the US, for example, the S&P 500 index, a broad measure of the stock market, saw its price increase from under 700 in March 2009 to over 3,300 this month, according to data from Yahoo! Finance.
Of course, markets don’t go up forever. Sometimes, they just flatline for a while as company earnings catch up with stock price valuations. Other times, they see violent drops that make big headlines, like the “Black Monday” stock market crash on October 19, 1987 that was felt around the world. It is funny how Black Monday and Black Friday have very different connotations from a headline grabbing perspective. But, actually, they have exactly the same meaning… things are on sale and there is an opportunity (potentially) to purchase a real bargain!
The reaction to the coronavirus outbreak is triggering steep stock market selloffs and increased volatility around the world. As of writing, major equity indexes in the US, UK, Europe, Japan, and Australia are significantly down, with our own FTSE 100 and FTSE Allshare index being the worst effected with losses YTD of around 20%. The main index in the USA, the S&P 500 is down 6.26% YTD and the wider MSCI Global Equity index is down 7.11%.
To bring a sense of reality to these market movements the IBOXX UK GILTS Index is UP 10.88% YTD and the IBOXX UK Corporate Bond Index is UP 1.85% YTD. This highlights the importance of having a balanced, appropriately allocated mix of equities (riskier assets) and Bonds (safer assets) to help withstand such dramatic falls.
In fact, investors in a portfolio that holds 60% in equities and 40% in bonds would have seen a return of -3.05% YTD and a portfolio of 40% equities and 60% bonds would have seen a return of -0.18% YTD
*data sourced from FE Analytics 10/03/2020
As we’ve said above, in times of expected market volatility we need to ensure we are able to (as best as we can) control the controllable. However, until we understand why we may react like we do then it is hard to know how to counteract this. We want to highlight the key behavioural biases in play right now which we hope can allow us to keep our emotions in check!
Recency bias – In 2019, the MSCI World Equity Index was up an impressive 22.74%. This year, so far, it’s down a modest 7.11%. Which number are we focused on? You already know the answer. Instead of celebrating the huge gains enjoyed over the past decade (157.63%), investors are fretting about the relatively modest losses suffered this year. Our thinking tends to be heavily influenced by whatever’s happened most recently.
*data sourced from FE Analytics 10/03/2020
Loss aversion – Recent stock losses and our sense that more damage may lie ahead is enough to cause many investors to panic. We simply loathe losing money. Indeed, experts in behavioural finance suggest we get at least twice as much pain from losses as pleasure from gains.
Anchoring – As of yesterday’s, market close, the FTSE All Share had given back most of the gains that it had delivered in 2019. If somebody had told you at the end of last year that the FTSE All Share would tread water for the next four months or so, you likely would have shrugged. But instead, we’re anchored on the FTSE All Shares January 2020 all-time high and the 19% decline since then. *data sourced from FE Analytics 10/03/2020
Hindsight bias – Because, up until a month ago, the brilliant returns of the global equity markets has lasted so long and because stock valuations have been significantly above historical averages, many investors have been expecting a bear market (sell-off) for many years, and they’ve been badly wrong. Despite that, there’s a risk that these investors will decide they predicted the current market decline. That, in turn, may bolster their confidence in their own financial acumen, leading them to make big investment bets in the future! We can’t predict the future, even if we believe that we have been expecting this for several years (a broken clock is right twice a day). Investing with hindsight can be one of the most dangerous and wealth destroying biases that we possess.
Illusion of control – Faced with danger, often our instinct is to act. That can make us feel more in control of our destiny, but it may not be good for our financial future. Most of us hold a portfolio built to help us pay for retirement and other goals and aspirations in the decades ahead. Should we mess with that investment mix simply because of a few rough days in the market? To ask the question is to answer it.
We want to finish with saying that fear is a natural reaction. We’re human and as humans, we’re hardwired to react to situations that threaten us. In this situation, we have a double whammy of fear. There’s the virus that can cause us bodily harm and the market reaction that can cause us financial loss.
Our reaction to the financial markets is something within our control. We know it’s no fun seeing our portfolio drop. But we also know market ups and downs are normal and should be expected. The key is to zoom out and look at the long-term big picture.
Our investment strategies are designed to support your long-term objectives, not today’s needs. And just like in farming, where we know there will be some lean years when Mother Nature doesn’t cooperate and other years when there’s a bumper crop, the financial markets are similar. Financial markets react to shocks to the system and (maybe) we are seeing one now.
In situations like this, our job is to bring perspective, to help you see that swift market drops are not unusual. And yes, the headlines are scary, and they can bring our “fear” instincts to the surface. We know how you’re feeling so please reach out to us if that would be helpful and have confidence that we are on top of the situation.
Please be prepared emotionally for more ups and downs but we must keep in mind that in the short term, market movements can be heavily influenced by fear and computerised trading, while in the long term, they tend to reflect broader-based economic trends. As investors, the challenge is to not let the difficulties of the short term prevent us from reaping the potential benefits of sound, long-term evidence-based investing fundamentals.
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Thank you for your continued trust and confidence