Understanding Market Dynamics
The $6.4 trillion global markets selloff on Monday August 5th, that also wiped off trillions of dollars over three weeks, was a sharp reminder of market volatility. Such events may be extremely upsetting to the retail investor, but personal finance experts generally have maintained routine advice: keep calm, resist knee-jerk reactions, and evaluate your portfolio very carefully. To navigate these turbulent times, it’s critical to understand what’s driving market movements.
Big Corrections
Zhu Hann Ng is founder and CEO of Kuala Lumpur-based Tradeview Capital. He says that by traditional standards, investors can usually count on a 10% or larger retreat once every few years, and 25% or larger pullbacks about once every seven years.
This week’s volatile performance was acute for recent markets. Japan’s Topix index had its largest fall since 1987 as it lost 12%. Taiwan’s main stock gauge also suffered its largest decline on record. Meanwhile, even some of the hottest wagers—on artificial intelligence and computer chips—fell into disarray. It all occurred as signs of American economic softening further stoked investor fears.
“It’s usually a bit of a fool’s errand trying to find one particular trigger for these kinds of selloffs,” agrees Rob Almeida, the global investment strategist at MFS Investment Management. In the end, it is usually a confluence of events such as overleveraged positions and a perfect storm of global economic and political uncertainties.
How to Sail through the Storm: Professional Advice
- Reassess Your Risk Tolerance
Market corrections provide a good opportunity to look back on your investment approach. According to Citi Private Bank investment counselor Dev Ashar, investors need to establish whether they are comfortable with their current holdings or whether their time horizon or ability to take risk has changed. For those borrowing money to invest, the best use of market rebounds is as an opportunity to decrease leverage and increase diversification, he said, perhaps by using some of the proceeds to buy bonds.
- Avoid Over-Concentration
Ned Bell, CIO at Bell Asset Management, warns that investors can drift into getting over-concentrated in thematic sectors currently in vogue such as AI. “While these areas will continue to have potentially high returns, they also may carry high risks. One rotation idea could be to add a little bit more into the less favored market segments, such as global small and mid-cap stocks, which can also serve as a good buffer to sector-specific corrections,” he said.
- Search Out Bargains
Market corrections present a chance to pick up assets at a discount — a buyer’s market. Alex Joiner, chief economist at IFM Investors, believes that downturns could give investors a chance to buy into the market, perhaps for undervalued companies. “Our pension fund took advantage of the recent dip with purchases in Japanese and Eurozone shares, selling government bonds,” Chief Economist of the Australian Retirement Trust Brian Parker informed us.
- Think About Geographic Diversification
Guy Stear, head of developed markets strategy at the Amundi Investment Institute, views the recent pullback as a buying opportunity, particularly in equities. He singles out Japan and certain European markets, noting they are potentially attractive and have given up year-to-date gains, even though earnings have met or exceeded expectations. BNP Paribas Asset Management’s Zhikai Chen said Chinese valuations are probably the cheapest anywhere and the Asian tech hardware sector offers some of the best upside.
- Keep things in perspective
While the slide on Monday was scary, a lot of analysts see it as an overreaction. Rupal Agarwal, quantitative strategist for Asia with Sanford C. Bernstein, described the selling as “panicked,” while admitting that the backdrop was replete with uncertainties over potential recessions, corporate profitability and geopolitical risks in the Middle East. Also, a number of economists and investment chiefs have maintained they still have a fundamentally optimistic view on the U.S. economy, one that has enough forward momentum that it should be able to sidestep a near-term recession.
Learning from Market Corrections
These market events serve as valuable learning experiences for investors. Hann points out that such corrections are a “reality check” in the sense that they remind investors of the fact that periods of irrational exuberance can never be sustained forever. By understanding the cyclical nature of markets, investors can better prepare themselves emotionally and financially for future downturns.
The Psychology of Market Volatility
Market selloffs have usually been able to elicit strong emotional responses from investors. This can result in impulsive actions leading to long-term negative impacts on their portfolio. It is very crucial to understand these psychological factors so as to be rational in investment during troubled times. According to experts, the answer should lie in an investment strategy formulated well in advance that keeps in consideration the periodic declines witnessed in the markets. The strategy can help investors not to drastically change their investments in reaction to short-term market moves.
Technology and Global Interconnectedness
We live in a highly connected global economy today; therefore, the movement of a market in one part of the world very quickly could have its impact at a global level. A recent example was a selloff that took effect across markets—across Japan to the U.S. Technology has increased the pace at which information and trades travel, thereby potentially creating more efficient cause-and-effect relationships across markets—spreading market volatility. This global context must be borne in mind by investors while going about looking at their portfolios.
Geographic Diversification
Geographic diversification— across regions and asset classes— can help to protect the investor against potential risk of economic or political strife that may be localized.
A Long-term View and Portfolio Review
While disquieting, the phrase “market correction” actually provides some hope for long-term investors. Portfolio reviews at regular intervals, ideally conducted during calmer market periods, can serve to help ensure an investment strategy continues to be on target with respect to an individual’s goals as well as the level of risk they are prepared to accommodate.
During such reviews, investors get to:
- Rebalance their portfolio in order to achieve a desired asset allocation
- Review performance of individual investments
- Consider opportunities for tax loss harvesting
- Consider whether their overall investment strategy still makes sense given life circumstances and financial objectives
The Value of Financial Education
While the benefit of financial education certainly extends past protection from the unforeseen, without question, events like Monday’s selloff are made more noticeable. This keeps investors well on course during these stormy times because they understand the market dynamics, principles of basic investments, and their own financial goals instead of getting panicked.
Conclusion
The calm before the storm, a market correction is bound to occur as it is an essential element of the investment landscape. If the investor maintains a long-term perspective, deploys appropriate diversification, and considers downturns an opportunity, then he or she can emerge successfully from difficult times. As Hann’s story about his plans for an October holiday paints so clearly, one continues to live life amidst the gyrations of the markets. Given a properly considered investment plan and the patience to withstand that short-term volatility, an investor can have a reasonable expectation of making it through without undue worry and stress and come out the other side in good standing with one’s financial objectives.
The real key to investment success isn’t running from market declines; it’s really about readiness for it and how to respond when it happens. An investor who is informed, diversified in their portfolio, and taking professional advice when necessary is better prepared for the storm and could even come out with the possibility of benefiting from opportunities that arise.
Acknowledgment: This article was inspired by and includes information from "What Bankers Say You Should (And Shouldn’t) Do When Markets Crash" published on Wealthmanagement.com. For more detailed insights, you can read the full article here.
