Markets are being driven by politics and they won’t stabilise while the eurozone situation is unresolved and, more importantly, while the threat remains that Spain or Italy could go the same way.
The eurozone accounts for around 10% of the value of world stock markets and European companies derive less than half of their profits from within the euro-area. What is going on in Europe has no bearing on housing starts in the US (which are picking up) or electricity output in China (which is not). Greece is neither here nor there in the context of a $14 trillion European economy. But markets hate uncertainty and that is what we must accept for the next few months.
Volatility of markets is something that we are going to have to get used to. Indeed, the dramatic ups and downs that have characterised the Japanese market over the 20 years of its post-bubble deleveraging could be the template for Europe as the painful process of mending the region’s balance sheets is endured for years to come.
This is an extremely difficult environment for investors, especially if your main experience of investing was during the aberrational years between 1982 and 2000, when everything went up and the investment industry’s idea of risk was moving too far from a rising benchmark.
Now the risk is the real one that you lose money and investors are quite rightly switching on to the importance of capital preservation. If you lose a third of your money you have to grow what you have left by 50% to get back to where you started.
A year ago the market fell sharply to a new trading range at the bottom of which investors looked at valuations (especially as indicated by the hard reality of dividend yields) and thought the rewards on offer made the risks worth taking. I expect something similar will happen this time around. European shares are cheap.
They trade on around 10 times expected earnings (just nine in the UK), dividend yields are often higher than those on corporate bonds and government debt, cash flow is strong and companies have lower levels of borrowings than for 20 years or so.
The corporate sector is quite strong. Investors have to make a decision in today’s volatile markets. They can attempt to catch the increasingly frequent waves and protect their portfolios during the commensurately frequent downturns or they can accept that this type of market timing is impossible. In that case they must focus on quality – companies with pricing power, good managements, recurring revenues, a spread of clients and robust balance sheets.
They must buy these companies at a sensible price and they must hold them through the inevitable sentiment-driven ups and downs. They must, in other words, follow the likes of Warren Buffett and think like business owners.
European politics and macro-economics are a mess but the region is home to many excellent businesses with fantastic prospects in places such as the US and the Far East, where life is going on even while Europe makes a hash of it. Shares in those companies won’t bounce back immediately, but in 10 years you may well look back and think that the summer of 2012 was a pretty good time to be investing in these long-term winners.
Five ways to handle volatility – FidelityWhile many investors are choosing to take risk off the table, this might not be the best strategy, particularly for those with long-term goals.
- Keep calm – “The worst thing investors can do is to over-react to market volatility. They will usually respond more slowly than the markets as a whole. This means they will be late to the party when markets rise and also risk bailing out after markets have already corrected, crystallising their losses.”
- Don’t blow things out of proportion – “The eurozone accounts for only around 10% of the overall market value of global stock markets. Europe is not the only story for investors today. “Even in Europe, many of the largest companies continue to do well, protected from problems on their doorstep by successful operations around the world and especially in the faster-growing emerging markets.”
- Diversify – “Investors should ensure that their investments are well-spread between different asset classes, such as equities, bonds, commodities and cash. Government bonds in Germany, the UK and US have all performed well during the latest bout of equity volatility as investors have sought safe havens for their money, providing investors with an important source of performance.”
- Consider the price you pay – “Longer-term what matters is the market’s valuation, so investors should look at the price they are being asked to pay today. The average multiple of a company’s earnings that a share price represents is actually cheaper than at any point since the late 1980s. Only at the bottom of the market in March 2009 were shares much cheaper on this basis than they are today.”
- Stick with it – “The beauty of regular saving, say monthly, is that it forces you to invest at times like these when the market has fallen and you instinctively prefer to walk away. That makes sense from a survival point of view (which is why we are hard-wired to do it), but it does not usually make sense from an investment point of view. Volatile markets create opportunities and a mechanical investment approach obliges you to take advantage of them.”
13 July 2012
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