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Doomsday headlines miss the point for investors

Short term nerves trump long term wisdom

Investors have a bad habit of doing the wrong thing in the wake of sharemarket lurches such as the one we are experiencing, basing their reaction on gut instinct rather than logic.

Newspapers will blare “billions wiped off markets” and nervous investors will obey their overriding nervous sentiment and sell. “Australian shares lose $57 billion” came up on ABC news and that will be one of many such lines.

“Bloodbath for sharemarkets” was another.

While it’s understandable, a sudden decision to sell is the opposite of how experienced investors like Warren Buffett tend to act when markets go down.

Because he’s always got a well researched list of the stocks he wants to buy, or in most cases buy more of, he’ll just add to his company Berkshire Hathaway’s holdings. He is happy to call himself a value investor so he’ll be buying into what might well be an avalanche of selling, and more or less choosing his price.

That’s not always easy for the rest of us mere mortals. Another common saying is that it’s hard to catch a falling knife, which is a way of looking at markets that are dropping.

Where will they bottom out? You’ll never know in advance. To use another old phrase, no one ever rings a bell.

The biggest Australian losers in the 2008 Global Financial Crisis were the retail investors who shouted “sell” while markets were wobbly and greatly favoured buyers over sellers, and then subsequently sat on their hands as markets slowly recovered.

There’s more psychology than logic in all of this. As prices picked up to levels above where they had sold in 2008, they asked themselves if they’d done the right thing in selling, rather than swallowing their pride and buying back in. That’s called compounding an error.

So, how do you avoid this problem? By averaging the cost of your investments. Professional investors do this all the time. If they like a stock, they’ll buy in a bit at a time, perhaps paying $2 a share when they start and paying up to $2.50 as the stock gets more in demand.

A very crude measure would say they have paid $2.25 a share for a stock now worth $2.50.

And if the share price drops? A well informed professional will have a model showing what “fair value” is for the stock, and they’ll tailor their buying (or selling) around that number.

If you really boil it down, investor markets are motivated by two things: fear and greed. It’s just as silly to buy a stock when everyone else is buying, unless there is an underlying reason for doing so. If there isn’t, you’re just joining the herd.

Investors battling feed and greed

Source: eInvest

So it is with selling, and fear. The current lurch is driven by two factors. The most obvious one is the revived possibility of a trade war between China and the US, but the other is that valuations on most developed world sharemarkets have been excessively stretched this year.

You could make a good argument for the notion that the China issue has been the trigger for what was already a long overdue drop.

But how bad a drop is it? What was the origin of all those billions that have been supposedly wiped off?

A cold hard look at the ASX200 index shows that you would be quite right in saying it’s fallen five per cent in August alone.

So far, so many billions wiped off. But if you stand back and look at how it’s gone in 2019, an entirely different picture emerges.

In simple terms, it was up 25 per cent on its recent low struck on December 23 last year, but now it’s only up 18.2 per cent.

The difference is that because most sharemarkets nowadays go “up the stairs and down in the lift”, falling much faster than they rise, no one ever writes “billions added to sharemarket”.

They probably never will, which is why you have to form your own judgements about the real forces underlying market movements.

And the best advice in a highly volatile market? Sit tight and do nothing, at least until a logical pattern emerges.

 

Disclaimer: Please note that this article shares the views of the writer, Andrew Main, and not necessarily the views of eInvest. This article does not take into account your investment objectives, particular needs or financial situation. As always, seek advice and read the PDS.