THE rally in equity markets from the lows of late March have tapered off in the last week, largely around growing concern for the longer-term economic effects of the covid-19 pandemic.
Last month the Bank of England warned that the UK economy was heading towards its sharpest recession on record, yet markets continued to rise. Is this a detachment of markets from reality? It’s a bit of a mind-boggler.
To help get your head around what’s happening in the markets, what needs to be considered are the starting points. The important thing to know here is that economic data is backward-looking and as such it is currently reflecting events that happened from March-May, as countries around the globe grappled with the effects of the pandemic and economic lockdown.
It might come as something of a surprise to realise that markets don’t actually live in the here and now. Instead, they act as a proxy for the future earnings and growth of the companies that they consist of.
As this column has touched upon in recent weeks, factors including the economic stimulus fronted by central banks throughout the world, the potential for a vaccine and improved preparedness for any secondary outbreaks have all helped to boost investor sentiment, driving market returns.
However, central banks around the world continue to lower their growth forecasts, and ultimately there will be some form of economic scarring from this pandemic. At this point in time, exactly where and how deeply, remain unknown. It looks as though relative market stability is still some way off.
With this in mind, how does an investor navigate such turbulent times? Or indeed, if you are a newcomer to the market, what should you be focusing on?
The first consideration is the level of risk you are willing to take. This varies greatly based on a range of factors, not least what the investment goal is.
For example, someone seeking a return of £100 from a £10 investment will need to take considerably more risk than someone investing £95 with the same goal. The optimal risk level is one that achieves your objective whilst exposing you to the lowest risk possible. Being comfortable with the risk you are taking with an investment is essential at all times.
The basic rule of thumb to answer this is: will you be able to sleep at night? Overall, with any form of investment, there is always the risk that you may get back less than you originally invested. However, those who are willing to invest over the long-term, in a diversified portfolio, will be more likely to reap the benefits.
This brings us to our second factor, diversification. Regular readers of this column will know we are fond of the old adage: don’t put all your eggs in one basket. The advice about spreading your investment wisely becomes particularly salient during times of market stress.
Having a diversified portfolio of assets can help to reduce the swings in value that can occur, or indeed help to manage “bubbles” within one particular asset class. We’ve seen this in recent months, as “risk assets” plunged during late March and conversely, perceived “safe havens” rallied.
A diversified portfolio should contain a degree of exposure to both and this in turn should alleviate some of the stress on the investor at times of crisis.
In my opinion, the real key is truly understanding the purpose of your investment. During times of volatility knowing why you have invested can help to provide much-needed perspective and this can prove to be a vital comfort for any investor when our confidence is tested.
If you invest with the knowledge and understanding that you may get back less that you put in, every pound of profit is a positive.
:: Cahir Gilheaney is wealth manager with Barclays Wealth Management in Belfast
