Share markets are very volatile places. If you read the textbooks, they shouldn’t be. After all, prices are supposed to reflect perfect information, and thus the markets are efficient.
Yes, that’s the theory. Those of us in the real world know it isn’t like that. This article isn’t about bashing the efficient-market theorists though (as fun as that is) – we have a much bigger problem.
Once we accept that the market is far from a calm, docile place (and unless you’ve been asleep for the past 3 years, you don’t need me to tell you that), we can turn our attention to how to respond.
Repeating past mistakes
The sad reality is that despite decades – centuries – of economic booms and busts, we don’t seem to be able to learn from the past. We continually commit the cardinal sin of buying high and selling low.
In 1999, many investors could only imagine a world of sky-high P/Es and a new investing paradigm where internet companies could be valued simply by counting the number of people who visited their website. A year later, the fallacy was exposed for the world to see.
In some ways, the reverse of that situation is far more sinister – and damaging over the long term. The global economy has been difficult for the past few years, and the ASX indices (and their international brethren) have reflected the gloom that has hit share prices. In some cases it was appropriate, as aggressive, over-leveraged businesses (yes, I’m looking at you, property sector) reaped what they’d sown. However, the pessimism that has gripped the market since 2008 has taken a long handle to almost the entire market, regardless of business quality, debt position or future potential.
Learn, reflect and respond
Rather than decrying the booms and busts, the much more pragmatic approach is to remember that it has always been thus. I think it’s likely that the 24 hour news cycle and rise of computerised trading makes the swings wilder and faster than in the past, but that doesn’t change the fundamental reality. As the saying goes, history may not repeat, but it rhymes.
These swings aren’t fun. When we reap the benefit of the market’s irrational exuberance, we feel wealthy, smart and just a little smug at how clever we were. When the market loses all hope, we curse our bad luck, sell our shares (often at the bottom) and swear off equities. And you know what? Neither reaction makes any sense at all.
As Benjamin Graham said, “You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right”.
So here we are; an unknown number of weeks or months away from the end of a pessimistic, listless market. Recent statistics suggest a great proportion of Americans have permanently given up on the stock market… and I’d guess the same type of sentiment exists in Australia. You only have to pick up a newspaper, turn on the TV or go to your favourite news site online to be confronted with the latest piece of terrible financial news from here or overseas. Debt crisis, currency crisis, the Euro is going to implode, Greece will default, Spain is a basket case… on and on it goes.
Some of these fears will end up coming true, most will not, and even those that come true are likely to have a smaller impact, on average, than the doomsayers predict.
We can learn from history
Share markets have returned over 10% per annum, on average, for more than a century – a century that included the worst wars humanity has known, the Great Depression, oil shocks, stagflation, 18% interest rates and nuclear and natural disasters.
We’ve taken the worst that can be thrown at us, and we’ve still managed more than 10%.
Please, ignore those who tell you that ‘this time it’s different’ – history is littered with stories of impending disaster that never came to pass, and – as the old joke goes – forecasters have picked ten out of the last two recessions. When disasters did strike, we have – without fail – resiliently overcome and gone on to become more prosperous.
All along, many of those who have slowly, regularly invested in the productive capacity of democratic capitalism (and ignored the noise) didn’t escape volatility, but still retired in comfort.
I have no idea how Greece will pan out, nor Spain. At the time, I didn’t know the impact that the oil shocks, Russian default, Asian crisis or tech wreck would have either. I simply know that over history, each low has been replaced with a new, higher, high and that the time to invest has invariably and perpetually been ‘now’.
Do yourself a favour. Remember today’s news is tomorrow’s footnote – or forgotten altogether. Be informed, by all means, but keep it in context. Focus on the long term, and buy well. If you do that, the passage of time will look after the rest.
Are you looking to take advantage of cheap shares on sale in today’s fearful market? Motley Fool readers can request a new free report titled The Motley Fool’s Top Stock For 2012. Click here now, whilst it’s still free and available.
Scott Phillips is The Motley Fool’s feature columnist. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
More from Scott Phillips