It won’t have escaped your notice that global financial markets have had a turbulent start to the year. Many of you will be anxious about what it means for your portfolios — especially those who are near to retirement.
As hard as it is though, you should try to put your emotions aside, focus on the facts and remember the lessons from market history.
Here are four things in particular to bear in mind:
Damage has been confined to specific market sectors like technology
If you were heavily exposed to technology stocks, you’ve had an uncomfortable ride. The tech-heavy Nasdaq Composite index has fallen heavily since mid-November and, as of 26th January, it’s down 14% for the year to date. The most high-profile tech fund to suffer has been Cathie Wood’s ARK Innovation ETF, whose performance has been on a downward trajectory since last February. At the time of writing, the fund is down a whopping 28% in 2022 so far.
But although, inevitably, there has been some contagion, other sectors have escaped relatively lightly. So far this year the broader S&P 500 index of US stocks is down just shy of 10%, which is the unofficial definition of a correction. The FTSE 100 is trading at virtually the same level as it was when January began.
“Investors in US large-caps and other highly valued growth stocks like the kind Cathie Wood was buying have been hit,” says investment author Larry Swedroe.
“But value stocks, for example, are trading at around their historical averages, maybe even cheaper, and they're not in a bubble in anything like the way they were when the market crashed in March 2000.”
“And we have the same situation elsewhere. Valuations in the developed world, outside the US, and emerging markets are around historical averages.”
What happens in January is no guide to the year ahead
There's an old saying on Wall Street that, "as goes January, so goes the year”. In other words, what happens on the financial markets in the first few weeks of the calendar year tends to set the tone for the rest of the year ahead. If the adage turns out to be true in 2022, we are certainly in for a rollercoaster ride.
But, on closer inspection, the "as goes January” theory turns out to be a myth. Since 1950 there have been 28 years in which January produced a negative return for the S&P 500. The average loss for the month in those 28 years was 3.6%. However, over those 28 years, the average return over the following 11 months was 5.4%. So a bad January for stocks has generally not meant a bad year.
Of course, the past does not predict the future. Stock markets may well fall further over the next 11 months. But it won’t be because they fell in the first few weeks of the year.
The gurus predicting a crash have been repeatedly wrong before
Investors tend to pay attention to stock market gurus at the start of each year, and also when share prices fall, so they’re particularly susceptible to market forecasts at the moment.
One of several gurus warning that a crash is coming is the well-known investor Jeremy Grantham. Stocks, he says, are overvalued and in a “superbubble”, and that it’s only a matter of time before a “wild rumpus” begins.
He may be right; nobody knows. But it’s worth remembering that Grantham has issued several similar warnings since 2013. His forecasts have generated huge publicity for himself and his investment firm, GMO, but investors who heeded his advice to sell out of stocks at any stage over the last eight years have missed out on very substantial returns.
Sooner or later, of course, Grantham will be right and markets will crash, as they always do. And no doubt then people will forget all those times he got it wrong and hail him as a genius.
But investors should heed the warning of Warren Buffett that predictions like these are dangerous. “I continue to believe that short-term market forecasts are poison,” he said in James Altucher’s book Trade Like Warren Buffett. “(They) should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”
Uncertainties abound, but they always do
The markets hate uncertainty, and there seems to be plenty of uncertainty around at the moment. For example, the Federal Reserve and other central banks are widely expected to raise interest rates, possibly several times, to combat rising inflation.
But there are other concerns too. It remains far too early to draw a line under the Covid crisis. Geo-political tensions over Russia and Ukraine, as well as China and Taiwan, could boil over any time. Here in the UK, meanwhile, a change of Prime Minister is a distinct possibility.
All of those issues have undoubtedly weighed on the markets in recent weeks. But we simply don’t know how any of them will unfold, let alone what the impact on the markets will be.
Jason Zweig of the Wall Street Journal summed it up neatly the other day when he wrote:
“I don't know whether we're on the cusp of a cataclysmic decline, or whether this is one of the market's normal see-saw rides. What I am sure of is that after two years of being cooped up at home with nothing to do but stare at market charts, a lot of my colleagues in the financial media are bored stiff. So reporters and editors will seize every opportunity to turn market molehills into mountains, and to extrapolate every drop into a correction or bear market.”
Remember, it isn’t investments that get tested in turbulent markets; it’s investors. And it’s not what the markets do that matters; it’s how you react. Yes, there’s plenty of uncertainty, but there always is. And although selling out of equities might provide some short-term emotional relief, it’s patience and discipline that markets reward in the long run.