Market Perspectives May 2020
Financial markets have rebounded strongly from a vicious sell-off, following an exceptional policy response to the COVID-19 outbreak. But volatility is likely to be high for some time.
01 May 2020
6 minute read
By Alexander Joshi, London UK, Behavioural Finance Specialist
As the consequences of the coronavirus pandemic unfold, what should investors do in the face of continued uncertainty and the resulting negative headlines?
A sense of eerie calm can be seen in the streets of major cities across the world due to quarantine measures taken by governments to tackle the COVID-19 virus. Meanwhile, turbulence persists in financial markets with a sharp bounce seen in April following March’s violent sell-off. In the face of such upheaval, what can investors do to focus on positioning for the long term rather than worrying too much about the short term?
While financial markets have rallied strongly of late, it is too early to get carried away on a wave of excessive optimism. Tentative signs of better infection statistics, despite the surge in cases in the US, and unprecedented amounts of monetary and fiscal stimulus have helped to fuel the rally.
However, without widespread testing, lockdowns are being lifted only gradually and social distancing is set to remain for a long period. Lifting restrictions too quickly risks further waves of infections and deaths. Meanwhile, maintaining lockdowns comes with sizeable economic costs. More swings in sentiment, and associated volatility, seem likely.
Until (and even after) a vaccine is widely available, the pandemic will affect much of daily life and market sentiment. For that, swings in sentiment can be so quick, and spotting highs and lows so difficult, that staying invested over the long haul can be the best strategy.
Swings in sentiment can be so quick…that staying invested over the long haul can be the best strategy
Paying attention to what the media is reporting and the compression of news cycles (together with a similar phenomenon in markets themselves) can exacerbate investors’ stress and anxiety. In turn, this can lead to a shortening of investment time horizons. In the context of volatile markets, a shorter time horizon can make investments appear riskier.
Unfortunately, this is just the moment when a calm and rational approach to portfolios is most necessary, as decisions made in response to short-term events can profoundly affect an investor's long-term returns. This can be exacerbated by a tendency to assign more weight to information we can more easily recall, known as “availability heuristic”. It creates a risk that investors place less importance on decades of strong market performance while lending more weight than warranted to periods of elevated volatility.
It is natural to expect more volatility for some time in response to a pandemic, when so much is still unknown. While unsettling, investors should remind themselves of their investment time horizon. It is likely to be far longer than that of market commentators fighting for airtime and visibility.
In uncertain and unprecedented times, markets are likely to overreact. The fear of losses or “losing out” can drive markets to overshoot, either in response to negative or positive news in the short term.
Good investment decision-making requires asking yourself whether market events are likely to affect your ability to reach your long-term goals. Much of the daily news reporting that focuses on a single market, industry, or company will simply not be material to a well-diversified portfolio. As a reminder, a portfolio diversified across asset classes, geographies and sectors, is unlikely to fully experience the impacts of headline market moves.
This is clearer when looking at a specific phenomenon, such as the cost of a barrel of West Texas Intermediate oil turning negative, as seen for the first time in April. While fundamental factors are putting much downward pressure on prices, the dive into negative territory was driven primarily by, unique, technical factors. In turn, it is important to understand what is moving markets rather than the headlines that simply scream the size of the movement.
Diversified investment portfolios...focused on the long term usually provide a strong foundation for weathering market storms
These are indeed unprecedented times. While history may not repeat itself exactly, it frequently rhymes. Diversified investment portfolios, constructed through a structured investment process and focused on the long term, providing a strong foundation for weathering market storms. These same squalls may offer opportunities that active managers can capture.
Markets are mechanisms in judging future prospects. In many cases, it is at the point of ultimate stress for most investors that the early signs of recovery are emerging. Exposure to riskier assets in periods when fear is as elevated as it is at the moment, can provide opportunities for those with cool heads.
The COVID-19 pandemic has created testing times for investors. But for those able to recognise how such events can affect decision-making, and put their money to work in a way that allows them to look beyond periods of uncertainty, it can often be particularly rewarding.
Financial markets have rebounded strongly from a vicious sell-off, following an exceptional policy response to the COVID-19 outbreak. But volatility is likely to be high for some time.
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