Over the last 10 years, the stock markets in the UK, US and much of developed world have witnessed incredible growth. This has led some to speculate that the stock prices might be a bit too high.
This raises the question, are we due another correction in the stock market? Should an investor try to avoid this potential fall in stock prices by staying out of the stock market?
Without a crystal ball, no one really knows for sure. Sadly, the stock market does not lend itself to this type of navel-gazing. Thankfully, there’s a lot we can learn from history about how to approach possible large falls in share prices.
Cast your mind back to the financial crises of 2008 which brought the global economy to its knees. The credit crunch hit with full force when Northern Rock suffered the first run on a British bank since 1866! By September 2008, several financial firms including investment banks Bear Stearns, and Lehman Brothers had gone under! The government stepped in to bail out several banks, including the Royal Bank of Scotland, Lloyds TSB, and HBOS, hammering out deals over a chaotic weekend to avoid the collapse of the banking system.
Share prices across the world plummeted. It was a very scary time for investors, and frankly most people in the developed world. Many investors saw their wealth plummet, and many questioned the received wisdom of investing. They were left wondering whether the benefit of diversification had failed.
So, what would have been the best course of action for an investor in this scenario? Hindsight is a wonderful thing. The best cause of action for a long-term investor would have been simply to sit tight and ride it out! A buy and hold investor in UK equities would have nearly doubled their money since the financial crisis!
If you invested £100 in UK equities in January of 2008, just before the early signs of the crisis, your investment dropped to £67.54 by February 2009 when the market bottomed. But if you persevered, your investment recovered and would have reached £190 by July 2017!
£100 in Global equities in January of 2008 was worth over £239 by the end of July 2017!
The return delivered by equities is in spite of the crisis! Thankfully, these types of crises are rare. Nonetheless, they are part and parcel of the capitalist economy. Leading economic historian Charles Goodhart noted that the last 300 years has shown many instances of financial crises and bank failure, with varying effect on asset values and the real economy. He believes that a financial crisis-free economy is ‘chimerical.’
The lesson here is that crises are part and parcel of our financial system. From reading the financial media the world seems to verge from one crisis to the next.
I’m often reminded of 78 reasons not to invest chart below.
However, every now and then, something goes wrong with our financial system despite the best efforts by governments and regulators.
And the best an investor can do during these crisis scenarios is to ride out the storm. In his recent letters to investors, legendary investor Warren Buffett sums up why we should invest for the long term, regardless of the occasional economic declines.
…a basket of stocks – is virtually certain to be worth far more in the years ahead. Innovation, productivity gains, entrepreneurial spirit and an abundance of capital will see to that. Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven helps them if they act on the nonsense they peddle.
Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie, not economists, not the media. Meg McConnell of the New York Fed aptly described the reality of panics: “We spend a lot of time looking for systemic risk; in truth, however, it tends to find us.”
During such scary periods, you should never forget two things: First, widespread fear is your friend as an investor, because it serves up bargain purchases. Second, personal fear is your enemy. It will also be unwarranted. Investors who avoid high and unnecessary costs and simply sit for an extended period with a collection of large, conservatively-financed American businesses will almost certainly do well.
At Engage Financial Services, we work with our clients to practise good financial behaviour. Often doing nothing is the best course of action, however counter-productive it may seem.
If you’d like to hear more, or for a full financial review, please don’t hesitate to get in touch.