Coping With Volatility
What a Year!
The Australian share market gave investors a bumpy ride last year. At the start of 2007 the All Ordinaries index was at 5,650. It climbed 14.3% by July, plummeted 12.2% over the following month, then put on a massive 20.9% to hit an all-time-high of 6,854 on November 1st. It closed the year at 6,421 before a miserable start to 2008. On March 18th the All Ords dropped to 5,163.8, a fall of 24.7% from its peak.
The ups in the market were driven by Australia’s booming economy and increasing company profits, underpinned by strong demand for resources from China and India. The downs were due to the now infamous sub-prime mortgage crisis, the result of sloppy lending practices in the United States.
Share market volatility causes a mix of confusion and concern for investors. When markets are falling, the natural reaction is to want to bail out, but what is the best course of action?
Portfolio Check
This is a time to look at the structure of your investment portfolio and the quality of individual assets. If the portfolio is well diversified, and provides exposure to a broad range of sound assets, then in most situations the best thing to do is to sit tight and ride out the storm. As last year clearly demonstrated, markets can recover very quickly.
It is also important to recognise the difference between the short term pricing of a share and its long term value. Price is determined by day to day market sentiment. Value is a function of the level and reliability of the earnings the investment will generate.
Here is a recent example. The sub-prime crisis has caused major problems for many US banks and financial institutions. Australian banks also fell in value, yet they have little or no exposure to the loans that have caused the problems in the US. The good news is that analysts expect Australian bank earnings to continue to increase in coming years. If this is the case, the fall in price represents an increase in value, which creates a buying opportunity.
A Caveat
This assumes, of course, that earnings will remain stable or grow. If Australia follows the US into recession, company earnings will be hit and share values will fall. However, most economists consider that the strength of our economy makes a local recession extremely unlikely.
Time In or Timing
Every day, the share market provides us with the benefit of another dose of hindsight. However, the simple fact is that it is impossible to predict the peaks and troughs of markets. In times of volatility it is well worth keeping in mind the old saying, “it’s time in the market that counts, not timing the market”.
Data source: Commsec