The paradox of the stock market: even when it falls, it often rises again
After a few good years, the majority of the European stock markets are in the red this year. Reason for panic or just a healthy correction in an upward trend? He who knows the answer for certain, should raise his hand. What we do know for certain is that corrections are fairly normal and you should sit them out to achieve an attractive return in the long-term!
2016 and 2017 were fine, but also actually very unique years for equity investors. The European stock markets closed nicely higher without any significant declines. From an historical perspective, you can even label them as highly unusual. Normally, every stock market year has a period in which share prices fall for some weeks or even months. That some people are now suddenly startled by red indexes shows once again how the stock market plays with the short-term memory of investors. Let there be no mistake: losses of 2 to 3% (calculated to the end of July 2018) are still reasonably limited.
Although it is quite understandable that the financial losses are painful for many to see, from a long-term perspective, this is still a normal situation by any means. Graph 1 shows why and provides a good overview of the annual returns of the MSCI Europe, a guiding index for the European stock market. The grey bars represent the annual returns and the red figures are the share-price losses recorded each year.
Graph 1 : MSCI Europe Index intra-year price falls vs. annual returns
Source : JP Morgan Asset Management
What should long-term investors take out of this: the MSCI Europe was positive for 30 of the past 38 years and the losses in one calendar year amounted to an average of 15%.
In other words, keep a cool head and don't panic. The stock market will rise in the long-term. Train yourself to have the discipline and emotional resilience to sit out those inevitable stock-market corrections. If you don't, you could incur unnecessary transaction costs with what may later turn out to be a sale when the market has reached its lowest point.
In our KEYPRIVATE portfolios, we accept the reality of interim corrections. Also, with the more dynamic profiles where they have a bigger impact. However, we do pay particular attention to bear markets in which share prices can easily drop 30% or more. To avoid situations, such as with the dotcom crisis in 2000 and the financial crisis in 2008, we have developed a number of trend indicators which should warn us in advance.
To date, we have not registered any alarm signals and we still consider these current share-price losses as a temporary downward correction. Should that sell signal still materialise, we will quickly increase the cash positions in our portfolios to hedge against increased volatility.
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