Market turbulence can be unnerving at times, particularly when the news headlines are yelling. Purchasing stock in a business entitles you to a portion of the future cash flows that come with ownership. Dividends or an increase in the share price are two ways that profits can be given to investors. The volume and timing of these anticipated future cash flows are highly unclear. Markets are never a smooth ride.
Investors analyse news as it enters the stock markets and reevaluate the company’s future. As a result, they modify their assessment of the fair value of the stock, which represents the worth of having a stake in the company. While bad news might have the reverse impact, good news can boost investors’ confidence or anticipation for increased future cash flows.
The recent market volatility, which is mostly due to uncertainty about the effects of proposed and changed economic policies in the US, serves as a reminder that stock ownership is not a free ride. The US financial markets are currently trading at levels comparable to those before to Donald Trump’s election. There is a lot of uncertainty, but there is always uncertainty.
Most investors would be well advised to accept the present stock price as fair, given that fresh information is priced into stock markets more quickly than most can react. Attempting to second guess stock market values is a game reserved for those with the confidence and ability to do so. While many people have plenty of confidence, research indicates that few people, including professionals, have the ability to do so.
As a result, investors have little option but to endure market volatility and acknowledge that owning stocks can be a challenging experience. There are no simple solutions; perseverance and patience are needed.
In these kinds of situations, investors should remind themselves of certain essential principles to prevent the possibility of making poor, even catastrophic, decisions. Additionally, this brief note includes some potent visuals that may reassure long-term investors.
Reminder #1: Avoid trying to time when to be in or out of markets
There is a temptation for investors to “wait out the storm.” Research[1], however, indicates that very few investors—professional or not—have the capacity to effectively predict when to enter or exit markets. The graphic below illustrates how risky it might be to attempt to do so.
Figure 1: Market timing can be costly
Source: Albion Strategic Consulting. Albion World Equity Index (https://smartersuccess.net/indices). Jul-07 to Dec-24. Daily returns in USD.
Reminder #2: The market falls from a peak every single year
Every year, the stock market declines from its peak. It is normal for the global stock market to tumble to lower levels. This makes it difficult, but it is essential, to stay involved through such setbacks. No one really knows where markets will go from here. This will depend on how investors react to newly released information, which is by definition random.
Figure 2: Every year, the market falls – global
Source: Albion Strategic Consulting. Data: Vanguard Glb Stk Idx $ Acc
The same is true when examining the US stock market in particular, which is currently the one market hurting investors the most.
Figure 3: Every year, the market falls – US
Source: Albion Strategic Consulting. Data: Vanguard Institutional Index I.
Reminder #3: Volatility is already factored into your financial plan
Markets are inherently volatile, a statistical indicator of how rough the journey will be. Interim volatility is a component of investment return assumptions. It is normal for markets to occasionally experience large and prolonged stock market drops. This is appreciated when advisers make the right choice based on their investing recommendations.
Although they cannot be prevented, declines in the value of investments can be reduced by holding a suitable proportion of high-quality bonds and exposure to the globe (diversification). By avoiding poor investor behaviour, investors can maintain reasonable expectations of investment results and improve their chances of success by making prudent assumptions about the future.
Figure 4: Market returns vary widely around the average
Source: Albion Strategic Consulting. Albion World Stock Market Index. 1985-2024. Returns in USD.
It’s possible that things will grow worse before they get better. No one will know for sure until they have the advantage of hindsight.
[1] E.g. Dai, Wei and Dong, Audrey, Another Look at Timing the Equity Premiums (October 11, 2023). Available at SSRN: https://ssrn.com/abstract=4586684 or http://dx.doi.org/10.2139/ssrn.4586684