A day in the financial markets can be a long time, especially when the world is moving quickly. Yesterday was a prime example of that, and one that both new and seasoned investors can learn a lot from.
For several reasons, the FTSE 100 index lost over 3% during London trading hours, and even more once the market had officially closed (via the futures market). This points to a Tuesday open lower as well.
What caused the sell-off?
In short, risk sentiment was negative. Investors the world over were concerned about the spread of the coronavirus, following the news of the outbreak in Italy. This meant the European stock index fell over 4%, also affecting stock markets in the US, and of course, here in the UK. During times of concern like this, many investors simply do not want to be involved in stocks (which are perceived as a relatively high-risk asset class) and so they sell.
Some hold the funds in cash, or they buy into perceived safe havens. Gold is one good example of this, which yesterday touched multi-year highs, and trades around the mid-$1,600 per oz mark.
Added to the worry around the virus was concern from the US that Democratic candidate Bernie Sanders could win the Presidential candidate nomination and set up a showdown with President Trump. This follows after he won the New Hampshire and Nevada state votes over the weekend. Market participants see Sanders as negative for the stock market. Again, the US stock market moving lower pulled the FTSE 100 index with it.
What lessons can we learn?
As someone who has seen large single-day moves such as yesterday many times before, the key thing I’d say is not to make a rash decision and sell due to one bad day. We should take a step back and look past the sentiment to the fundamentals of the index price. Within the index, there are firms that have strong balance sheets and are very profitable — I recently reviewed three here.
The sell-off has made firms such as these cheaper to buy, even though the business may be completely unrelated to the virus or indeed the possible impact of Bernie Sanders! This shows how risk sentiment in the short term can often cloud the longer-term picture.
Fear and greed are two characteristics that market participants often show, which can put share prices (and the index as a whole) at unnaturally high or low levels. When the dust settles, the share prices in the longer term return to the fair value.
What this means for the sell-off yesterday is that if you’re invested, you shouldn’t be selling out prematurely on the back of one losing day. For those looking to get in to the market, you can pick up some stocks at relatively cheap levels, which are fundamentally not deserving the hit to the share price due to the external factors of yesterday. A good example of this is Severn Trent.
Jonathan Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.