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Smart Investor: how to profit from a shell-shocked market

The prevailing economic gloom creates the ideal hunting ground for value-focused investors, says Smart Investor.

 
Smart Investor: how to profit from a shell-shocked market

The herd is now fearful and willing to sell cheap, says Smart Investor, creating opportunities to pick up quality stocks at attractive prices.

Hard times

I came across an interesting statistic recently which said that 25 years ago one in four news stories was positive, while today the figure is just one in 18. Unfortunately, I have no way of verifying this statistic, but it does feel as though there is very little good news around at the moment – especially in the financial world.

You could be forgiven for thinking that the Western world is now part-way through its final chapter, with the Brics (Brazil, Russia, India and China) seizing the lucrative franchise of wealth creation.

Recent news has been dominated by the crisis in Europe, the stalemate in America and consistently disappointing figures for almost every economic measure you care to look at. Sometimes it feels as though one positive story in 18 is a tad optimistic.

The start of a lost decade?

There's no doubt that things are tough. Unemployment among 16- to 24-years-olds has topped 1 million for the first time in two decades, with employment opportunities for the rest of the population also being limited. In addition, GDP growth is scarce and has been for a while now, with the UK economy pretty much flat-lining for the past three years.

It seems there is now an acceptance that the next decade will be something of a ‘lost decade’ reminiscent of Japan in the 1990s, when it was touted as a serious competitor to the USA but went on to disappoint for the next 20 or so years.

Among all the doom and gloom, however, there is always at least some opportunity – if you look hard enough and are able to put your emotions to one side, that is. The reason for the existence of opportunity is simple: the stock market is ruled by fear and greed, and these emotions cause share prices to over-react and under-react to positive and negative news flow.

Opportunity knocks

Currently, the general feeling among most investors is fear and an acceptance of defeat – hence 17 out of 18 stories are apparently negative. By this I mean that many investors are once again saying that investing in shares is of little use, since the index has actually fallen over the past 10 years.

Surely, they argue, it is better to buy assets such as gold and gilts – both of which have performed well over the past few years in particular, while stock markets have plunged, recovered and then fallen yet again.

This, then, is the opportunity. The stock market is behaving like a worried herd, fearful and doubtful as to whether there is much point in buying slices of companies anymore. Astute investors will realise that in order to buy quality companies at attractive prices, the herd must be fearful and willing to sell at low prices. Times of economic difficulty and concern cause such emotions to prevail.

History lessons

Asked how he felt in 1974 (when the Dow Jones had been flat for 10 years and had fallen from around 1,000 points to 600 points) Warren Buffett said 'like an oversexed guy in a harem'. The Dow’s next 20 years saw it go up sixfold.

This is not a prediction for the next 30 years, but a reminder that doom and gloom creates opportunities to buy shares at cheap prices. The future may appear to be bleak, but this is precisely the time to be seeking out companies in which to invest, even if many investors have been scared off.

24 comments so far. Why not have your say?

Ali B

Dec 01, 2011 at 08:49

No, the time was over the last 3 months up until two days ago...

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Anonymous 1 needed this 'off the record'

Dec 01, 2011 at 09:18

You're a great contrary indicator. Here comes a massive sell off in the market then!

Really can't see your logic when we're about to witness the break up of the EU and several countries are on the verge of bankruptcy

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Truffle Hunter

Dec 01, 2011 at 09:48

Dow/Gold Ratio =1 represents a good and almost risk free point at which to be secular bullish. We are a long way from that. Dow, SP500, FTSE etc are all down in terms of gold over the past 10 years. That said, we could now be at the start of a cyclical bull for stocks for a few months within a secular bear for many Western stock markets.

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Anonymous 1 needed this 'off the record'

Dec 01, 2011 at 09:55

"risk free"?

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Mickey

Dec 01, 2011 at 10:36

Interesting thoughts so thanks for that but I'd like to see more meat on the bones, which sectors/regions etc do you think offer most opportunity?

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Truffle Hunter

Dec 01, 2011 at 10:53

When markets look their worst the risk factor is at its lowest - perhaps not risk free!

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Anonymous 1 needed this 'off the record'

Dec 01, 2011 at 11:14

Agreed. My view is that it's currently 50/50 whether there will be a massive rally or a massive crash. Hyper-inflation could mean stocks go higher but defaults in the EU could mean confidence is shot and stocks will sell off. Trying to predict (the most dangerous word in relation to the markets!) which way it may go is just gambling in my opinion. You are better off investing in something that is market agnostic and directional....nothing more

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snoekie

Dec 01, 2011 at 12:13

Anon1, given the Euro problems more than 50% chance of major upheavel in the coming months because of ongoing dithering.

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Anonymous 1 needed this 'off the record'

Dec 01, 2011 at 12:30

Ok, then call it 60/40. If you are short, there is still a 40% chance you would get cleaned out by a rally.

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JEL G

Dec 01, 2011 at 14:07

Well, I have been buying on the dips for a little while now and will be for some time to come as I have great faith in a longer term recovery. Maybe many years but so what as long as the divis keep rolling in.

Like it was stated by Warren Buffet, I also bought during the big recession of the 70's and did very nicely out of the situation.

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Robert Court

Dec 01, 2011 at 14:14

JEL G

Good to hear you did very nicely out of the 70's and hope you have equal success this time round.

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William Phillips

Dec 01, 2011 at 18:47

If you stopped thinking of the market as a casino where you have to be on the right number when the ball falls in, and began thinking of it as a place where you can pick up a spread of sound companies with growing streams of income (tax paid in most hands), you would rarely be disappointed.

You would not have been let down had you bought such companies on the eve of the Millennium. Whatever happened to their share prices due to the exaggerated reactions of the hysterics who 'play the market', your dividends would have grown handsomely in real terms and your purchasing power from uncertain wages, fixed and unincreasable bond interest or meagre returns on cash deposits would have been supplemented by the fortitude of blue chips' payouts.

That was the function the Stock Exchange was set up to perform: matching permanent investors to good businesses and allowing them to raise more capital. All the nanosecond automated trading that is the reductio ad absurdum of the speculative froth seen in the LSE's greater days could be abolished and still this function would be needed-- and remunerative for those who buy and hold for ever. They are only doing, in miniature, what Mr Buffett prefers to do.

But it needs patience and a complete absence of the 'something for nothing' mindset that pervades our modern, debt-sodden society, so most investors will go on betting and losing.

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JEL G

Dec 01, 2011 at 19:57

Good on you William Phillips. We must be in the same age group.

I have been long term investing for over 40 years now..............

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Anonymous 1 needed this 'off the record'

Dec 01, 2011 at 20:52

It's all very well saying that Jel G and Mr Phillips but if you carry on investing in this manner, I believe there is a very good chance you'll wipe out a vast proportion of your wealth at some point. You seem to conveniently miss that you and Buffett have participated in one of the greatest bull market runs in history and even just quoting Buffett (who is a statistical anomaly) immediately brings your credibility into question as there is not one other person who has invested in his manner with any success over a long period. Buy and hold no longer works and before you get on your soapboxes about the "casino" market these days, read "reminiscences of a stock operator" and you'll see that short term speculation was just as rife in the early 1900s.

By buying a "spread of sound companies with growing streams of income", you are not diversifying your risk in any way and if the market goes down, they're ALL going down. Were it not for QE2 when the Dow was at around 7-8,000, there was every possibility that it could have halved from there which would have destroyed the dangerous notion of "buy and hold" for good.

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Robert Court

Dec 01, 2011 at 21:09

Anon

If people have survived 40 years of investing they will have experienced several recessions and have some confidence in themselves and probably have enough wealth not to be too concerned even if the value of their shares plummet by 50% as long as their dividend income doesn't totally dry up.

Personally I have problems with the 'growing streams of income' in that if you bought a share for £1 donkeys years ago and it now pays £1 per annum in dividends and you beam and say you're getting a 100% annual return on your original investment it seems to ignore the present value of the share; if the share is now worth £20 then your huge £1 is only a 5% annual return on its present market value.

I HAVE to respect those who have not only survived but prospered and realise that once you have a huge amount of capital that a perceived safe return is better to them than a higher riskier return, but all I know is that in the above example I'd want to sell at £20 and reinvest elesewhere for a better return!

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William Phillips

Dec 02, 2011 at 00:17

Anon: "By buying a "spread of sound companies with growing streams of income", you are not diversifying your risk in any way and if the market goes down, they're ALL going down."

There you are, you've fallen straight into the trap of assuming that I am after capital gain when I've told you all I want is dividends. They don't collapse during recessions, in fact the majority of companies have continued to raise them through 2008-2010 despite being supposedly in the middle of "the worst slump since 1929-32", yadda yadda.

I was blooded as an investor in 1973-75 when we not only had a worse stockmarket crash but inflation that peaked at almost 30%. I've seen the best and worst that the alternation of greed and fear can do, and by concentrating on long-term buy and hold and yield I've let nearly all of it slip over my head. I have not done a stroke of paid work for more than ten years and today I am almost as rich on paper (not that it matters) as in 2007,

"if the share is now worth £20 then your huge £1 is only a 5% annual return on its present market value"

So what? All I want is a rising tide of income to pay my bills. If it falters, I switch. Nearly always it doesn't. My income is now large enough that I save more than half of it. One day I'll learn to be a good little advertising-bewitched consumer, but my life is happy without most of what the world is taught to think essential to happiness.

I adhere to the the Victorian value of living off income and not touching capital. Charities and my relations can have it.

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Robert Court

Dec 02, 2011 at 07:18

William Phillips

Thanks for your post and I salute your values.

I'm also not too bothered by short term paper losses in my investments as long as they cough up the interest payments (corporate bonds) but there is obviously a relationship between capital and income and, over time, capital needs to increase to give an increased income.

I also avoid, wherever possible, spending any capital (even if it has diminished in value).

I agree 100% on living off income [hopefully with 50% reinvested] and also mostly agree on refusing to be persuaded I need things that I know I really don't need.

Two nights ago I was invited to share a meal with a German couple in their luxury bungalow of the hotel they are staying in for six weeks.

They would not be able to afford a six week holiday in a four star hotel if they had 'essential luxuries'; they live in Berlin with an excellent transport public transport system and the husband gave up owning a car 15 years ago.

They own no television or mobile telephones and the savings must help towards paying for their luxury holidays!

My father also used to live a very frugal life but enjoyed taking my mother on very decent holidays he'd spent many months planning in advance. He owned a car but when he died in 2008 it was the same car he'd bought new in September 1963 and had been round the clock over ten times [10 x 100,000 miles].

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Gary Fry

Dec 03, 2011 at 09:08

William Philips makes some lucid points. Thanks for that, William. Inspiring.

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Paul G via mobile

Dec 03, 2011 at 09:39

William Phillips

You touch on the fundamentals in regard to values of what we can afford in relationship to what we want and the need to live within our means. Not spend before we have earned and need to generate real not virtual income

If the government had adopted this approach since the mid 1990s then we would be in much stronger position. I fear that these values are completely foreign to so many now it gives little hope they will accept the need to change. These values represent the difference between UK and Germany most importantly at populace level not just government level which just represents national psyche just as UK government does unfortunately.

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Robert Court

Dec 03, 2011 at 09:50

Exactly......... although even the German government is in considerable debt.

Economists would like German consumers to spend more.

Why should they?

The last time I visited Germany everybody I saw had a good standard of living without the need to buy more and more new 'stuff''.

There is no greater satisfaction than WORKING and SAVING for something you really want for some time in the future; obtaining something NOW without working and saving for it both devalues the pleasure and leaves a cloud hanging over you when you have to work for it in arrears and by the time you've paid for it 100% of the pleasure obtained has almost always gone.

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ALAN P

Dec 03, 2011 at 10:11

I'd just like to also comment on the input from William Phillips. What inspirational thoughts indeed. Investing for the long term is an art form and takes many years of trial and error. Reading the thoughts of a very experienced investor really does remind us that daily market movements really is nothing but noise! Thank you for your input William very much appreciated

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bb 42

Dec 03, 2011 at 11:36

The Dow Jones example

By the same token why did't the Japanese market recover after all it was at 30000 in 1990's

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cherrybowl

Dec 04, 2011 at 05:56

Quality,I have learnt is the only syntax to base any judgement,whether buying shares,personal relationships or taking a photograph(you get the picture?)You can only sleep in one bed,watch one telly,eat one meal, drive one car etc. So get your values right-in the long term substance always wins over style

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William Phillips

Dec 04, 2011 at 14:33

Thanks to those who have agreed with my take on the present discontents.

I feel ashamed of the short-sighted selfishness of my own and the next generation, which is bequeathing so poisonous a legacy of indebtedness and economic malaise to our youth. But I detect an adaptation, a rejection of false materialist values and a gritty willingness to do better among many students and newly employed young people who have swerved round the media brainwashing (internet, take a bow) and begun to reason for themselves.

You don't have to camp outside St Paul's to know that bottomlessly bailing out banksters and letting ceos earn hundreds of times as much as their workers is no necessary or desirable part of capitalism. That form of economic organisation's sole justification is that allows more individuals to live more freely, with more options and less dread of the Four Horsemen, than the other systems. If capitalism can't do that any more, it deserves to perish... and the City, the whole casino kit and caboodle, with it.

However I think and hope that a fairer and juster synthesis of private enterprise and social responsibility will come out of the mess the Boomers left, and that our young will rise to the challenge of evolving a better system. An earlier cohort of the young retrieved us from the world wars and depression the old men foisted on to them. At least the Boomers only ask young people to be poorer than they have been themselves-- not to be conscripted and die for the Boomers' mistakes.

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