What a dramatic week for the markets. 
Earlier this week we shared a few thoughts on what is driving the slide in global stock markets and provided some investment ideas for those deliberating over what to put their ISA, or whether to even invest at all.
There’s been a lot of focus on the banking sector this week, with European banks being hit hard. Inevitably, many have observed parallels with the events that kicked off the last credit crisis. However in my view the situation is different and there a cocktail of concerns dogging the markets, with China are the epicentre, but a thread across this is a growing sense that central banks are no longer in control of events and that can be seen manifesting itself in the spike in Gold prices.
Performance of indices in 2016
Source: FE Analytics
Gold is the panic asset of choice, favoured by investors at times when confidence in the financial system is weak, because it is seen as a store of value, that cannot be debased like a paper currency.
What we are seeing playing out is a rapid reassessment of risk, across many asset classes.
If you’ve read our previous musings, you’ll know that for some time we have been banging on about the distorting impact central banks such as the Fed have had on asset prices in the aftermath of the last financial crisis.
Ultra-low interest rates and the vast “QE” money printing experiment across several regions have provided relentless liquidity and turbo-charged investment returns.
In our view, valuations had become stretched across many asset classes and markets were being too complacent about risk. In short, investors had been taking it for granted that central banks would always be there to provide a crutch to support markets.
While QE and rock bottom low rates have certainly boosted investment markets, their impact on the real economy is far less convincing and in many ways such policies remaining in place for so long have caused damage by propping up weak businesses and suspending a normal but necessary cycle of bankruptcies and defaults.
Failure is a necessary part of capitalism, to clean the system of past excesses. Instead, years of loose money has allowed cash to flood into property and stock markets and encouraged companies to borrowing money and buy back their shares, rather than invest for growth.
Capital investment has remained weak.
But with the slowdown in China, a weakening outlook for global growth and the US economy starting to falter, anxiety is now being unleashed across the markets with a radical reassessment of risk.
Performance of indices over 1yr
Source: FE Analytics
What underpins this is a dawning realisation that central banks are running out of policy options to ride to the rescue and save the day again. Rates are already low and QE is becoming discredited.
The surprise move to negative interest rates by the Bank of Japan, following similar moves in Europe, seems to have exacerbated the situation, as it suggests rate-setting authorities are running out of options and this has simply stoked concerns over the impact on the profitability of banks.
So, rather than seeing this as a repeat of the banking crisis, we are seeing markets lose faith in central banks and reprice investment markets to reflect the reality of a global economy which is still fragile and where the growth outlook is weak.
So what should investors do?
Well there are the decisive and specific things that might be done – is it time to buy Gold? Shift into cash? Absolute Return funds?
However, I also believe this is a time when investors need to reflect on some of the basics, as much as the “clever” things.
In particular, remember it is nigh impossible to second guess for sure when a market has peaked or bottomed, but what we do know is that share valuations are a whole lot more attractive now than they have been for some time and that in very simple terms, the art of successful investing is to buy when markets are weak and sell when they are high, not the other way round.
Or, as Warren Buffet put it: “Be fearful when others are greedy and be greedy when others are fearful”.
The outbreak of complete bearishness is perhaps a sign of capitulation. Markets usually overshoot on the way up and on the way down, so while the rout could run for a while, for long term investors this is a much better entry point than we’ve seen for some time.
Now, it is quite possible that the shake-out in stock markets will continue for some time yet, so I’m suddenly turning into a raging bull here.
But rather than avoid investing altogether, a simple way to mitigate some of this volatility is to drip feed new money in, either through regular savings or by phasing in your cash over a period of weeks and months, rather than heroically piling in with a single large lump sum.
Remember the end of tax year deadline for using your ISA allowance, is only a deadline to put your cash inside the account, you don’t have to invest straight away.
Until recently investors have enjoyed a prolonged bull run for shares, powered of course by all the stimulus and low rates I mentioned earlier. But markets never rise in straight upward line forever.
Many however may have forgotten other, more boring but less volatile asset classes during the years of soaring stock markets. As we are now in tougher times, it is worth reconsidering the importance of diversification – even an aggressive portfolio shouldn’t 100 per cent exposed to equities in our view.
Take a long at absolute return funds or commercial property trusts (where premiums have now turned to discounts).
Discounts on direct commercial property trusts
Source: The AIC
Finally, diversification also means holding a mixture of investment approaches, as well as funds in different asset glasses or focused on a mixture of geographies.
Yet in recent years, some have believed adopting a single approach, namely passive investing is a panacea because of the low costs of such an approach.
Well it isn’t and those who have pursued a narrow and dogmatic approach like this, will have been fully exposed to the slump in markets. There are many different ways to manage money, and some will work well at a particular time and place – a well-built portfolio will have a full box of tools available.
Jason Hollands is manging director of business and communications at Tilney Bestinvest. All the views expressed above are his own and shouldn’t be taken as investment advice.
