The Motley Fool

Why an impending crash should be no reason to panic

Global markets have been on a nine-year bull run and good value shares have become harder to find… until recently that is. The FTSE 100 had been hitting new highs and an almost unprecedented period of rising share prices had started to make commentators nervous. When you add in the macro problems threatening the economy, it is easy to see why the recent sell-off that made global headlines occurred. Rising interest rates, Brexit, and trade wars have made bonds seem more stable investments relative to perceived risk.

Don’t try to predict the future

It is generally a bad idea to base investment decisions on macro factors, for a couple of reasons. Firstly, without the benefit of hindsight, it is almost impossible to predict how macro factors will play out. Most people thought that the UK would stay in the EU and Hilary Clinton would be the American president, but history makes fools of us all. Secondly the stock market is a discounting mechanism that reacts to sentiment. This means that the markets react ahead of time leaving little profit to be made if you agree with popular market sentiment.

It’s also dangerous to go against the popular market sentiment as share prices will only begin to change when the market starts to care about the underlying issues. For example Brexit fears have been growing for a couple of years, but prices have only recently started to reflect this uncertainty, all the while the FTSE has been rising. You can lose a lot of money betting against the market. 

Keep calm and carry on

The important thing to remember is that when you buy shares you are buying part of a business. If a business is profitable and paying dividends or reinvesting them, you will earn money over the long term. Share prices may have been rising for the past nine years but this is unsurprising as those businesses have been generating cash and reinvesting.

One approach to navigating share price volatility is to take an approach called pound-cost averaging. This is where you invest regularly over a period of time to iron out the fluctuations in share price. This approach is similar to indexing as it should give you an average return over an extended period of time. But I prefer to buy on the dips to try to grab a deal.

Is now a good time to buy?

There is no way to say if the market will drop lower, although it is clear that the market has started worrying about macro factors and is becoming bearish. It is easy to say that you should buy on the drops, but it is impossible to tell where the bottom is. My approach is to drip-feed money into the markets as the share prices of my preferred stocks are falling. I am satisfied with the stocks that I hold, therefore buying them at 10% less than I would have paid a fortnight ago is a good deal. If shares fall another 20% then I’ll be happy I’m getting a bargain.

It’s also time to look closely at value instead of momentum. Stocks that have been rising on price momentum rather than earnings power will most likely see the biggest falls. My advice is to stick to fundamental principles, sit back and have a cup of tea.

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