NAIROBI, Kenya, Jan 14 – Financial markets around the world have recently experienced significant volatility. Much as it has “burnt the fingers” of short-term investors, this volatility underlies the case for a long-term approach to investing in the stock markets.
Even though unpredictable events and changes in investor sentiment can have a negative impact on markets, investors in the stock exchange need to understand that down periods such as those recently seen are inherent aspects of equity investing.
Investors are therefore cautioned that short-term declines should not detract them from the long-term potential of stock market investing. Looking at major economic events in history, it would be somewhat accurate to predict that the stock market will bounce back from the rubble and for that matter sooner than later.
The crash of 1987 shook the United States but in came renewed investor confidence that propelled the nation to what it is today, the world’s largest economy. The financial markets have withstood tremendous shocks over the last few years. Few can forget the trauma of the 9/11terrorist attack, the declining stock market returns from the highs of 2000 and the bankruptcies of Enron, WorldCom and United Airlines.
The financial crisis of 2008 has brought several terminologies to the fore; credit crunch, short-selling, toxic debt and deleveraging.
The “credit crunch” also known as a credit squeeze is a sudden reduction in the general availability of loans (or credit), or a sudden increase in the cost of obtaining loans from financial institutions.
There are several reasons why this may happen. The most common reason is anticipated declines in value of collateral used by banks when issuing loans or even an increased perception of risk regarding the solvency of other banks within the banking system. This was the case with financial institutions in the US and Europe.
Short Selling is a way of profiting from a fall in a company’s share price. The investor can sell stock that he/she does not own, with the aim of buying the shares back at a later date at a lower price. The investor later returns the stock to the original owner pocketing the difference as profit. Many investors, notably hedge funds, use shorting techniques with the objective of achieving returns from falling share prices.
A typical short sale works this way: The investor, usually a hedge fund or large investment bank takes the view that shares in a particular company are set for a fall. The investor then borrows the shares from someone who does own them, most often a large pension fund or insurance company and sells them in the market. Once the shares have fallen in value, the investor buys them back at the lower price and returns them to the lender.
If all goes according to plan, the investor is paying less to buy back the shares than they received for selling them. There are some costs involved, notably that the lender charges a fee for loaning out its shares, but in an ideal world the shorter still makes a tidy profit.
Short selling is associated with many controversies with many economic observers associating it with market abuse. Speculation can cause the sudden collapse of a listed company’s share price with short sellers making enviable gains upon market recovery. Short selling could also stabilize a company with adverse effect on its long-term viability.
Toxic Debt refers to bonds that are vulnerable to losses. This is more relevant to advanced financial markets.
Deleveraging refers to a company’s attempts to decrease its borrowing levels by settling portions of debt. It is known that many companies borrow to finance their operations.
Companies that are highly leveraged may be at risk of bankruptcy if they are unable to make payments on their debt. Given the recent high-profile bankruptcies such as Lehman Brothers, numerous financial institutions are currently trying to bolster their balance sheets by deleveraging. The effect of this is to reduce the amount of credit in the financial system.
Since both companies and consumers now find it harder to obtain loans, the ultimate result is a slowing down of the economy.
There are several lessons that investors can learn from the behaviour of stock markets. Investors need to look at downturns in the stock market as good buying opportunities. As John F Kennedy once said, “When written in Chinese, the word crisis is composed of two characters. One represents danger, and the other represents opportunity."
Doing so will enhance your portfolio’s long-term returns when the market rebounds. Nobody can predict exactly when markets will decline or rebound. However, a strategy of adding to holdings when they are “on sale” may provide significant advantages over a strategy of pulling out of the market when prices are at their lowest.
In addition, no investor wants to miss the market’s best performing days. Over every market cycle, there will be up days and down days. Missing even a few of the stock market’s best-performing days can result in significantly lower returns from investment in the stock market. By trying to time the market and potentially getting this wrong by even a small margin, you may potentially miss out on market rallies that can substantially improve your overall return and long-term wealth.
The greatest lesson an investor can learn from the stock market is to be diversified. Not all investment types perform in exactly the same way during similar time periods. Investing across multiple investment strategies, styles, sectors and regions reduces risk and enhances the potential for investing in the best-performing asset class while reducing the impact of investing in the worst-performing products.
Not all investors have the time, knowledge, experience or perseverance to navigate the turbulence of stock markets. Professional investors however do. Thus engage the services or professionals who not only have the experience Let Professional Investors Do the hard work have the experience, investment insight, global resources and breadth of investment products to help investors stay the course and meet their financial goals.
Hesitation and pessimism have no place in the stock market today. Get in now and stay there for the long-haul. It is only then that such investment will pay out dividends literally.
(Renaldo D’souza is the Marketing and PR Coordinator at Winton Investment Services Ltd, an Offshore Investment Advisory Company based in Nairobi)