It has not been an especially good summer for stock market investors. Some might even say we should have packed our bags in May and gone away, as the well-trodden stock market adage recommends.
However, going away in May would not have saved you this year. The market was already in sell-off mode by then. Since hitting a high for the year of 5,825 points on 15 April, the FTSE 100 index has lost almost a fifth of its value. Moreover, it has closed below 5,000 points on no fewer than seven separate occasions since April. So, should we be worried?
There is certainly no shortage of bad news. These include the massive oil spill in the Gulf of Mexico, signs that growth in China may be slowing, a sovereign debt crisis in Europe that refuses to go away, inflation that the Bank of England seems reluctant to tackle and an emergency Budget. The UK economy could slip back into recession.
We can’t say we were not warned, though. Legendary investor Warren Buffett predicted this in February 2009. Admittedly, he could not pinpoint the exact events that would blight individual countries, but he did caution that the economy would be in shambles throughout 2009 and probably well beyond too. However, he stressed that shambolic economies do not tell us whether the stock market will rise or fall.
Market falls can be a boon. After all, if you are a long-term buyer of shares, you want prices to drop occasionally so you can buy them cheaply. You need to be greedy when the market is fearful and fearful when the market is greedy. Fear and greed are unquestionably powerful emotions, especially when mixed with recent event syndrome. This is where something is considered to be vitally important simply because it is the most recent thing that has happened. When you see the price of your investment fall, it is easy to convince yourself that the decline must be attributed to something that has recently happened – even if it’s unconnected.
It is not easy to eradicate emotions when investing. One way to overcome this is to ignore entirely the price you have paid for a share. Instead, focus on other attributes such as the dividend forecast.
What matters is how much the investment is worth now. If it is significantly overvalued today, then you may consider selling it. However, if they are seriously undervalued, then consider buying more. Whether the shares are in the red or black should not have any bearing on your decision to buy or sell.
UK shares do not look expensive. It implies that investors are paying £10 for every pound of profit companies make. An earnings yield of 10 per cent compares favourably with gilts, unless you are a predisposed to recent event syndrome.
David Kuo is director of financial website fool.co.uk