We are now well into August and most people use this time to take a holiday. Accordingly, it is a month when I tend to notice two things. First, meaningful headlines and news stories are often thin on the ground. Second, with many traders and big decision makers taking a break, the level of trading within the stock market is quite often lower than during the remaining months of the year.
In this environment, markets are often more vulnerable to severe swings. We have certainly seen a number of setbacks this summer, which presents the prime opportunity for many news writers to create even more negative headlines. After all, it has always been good copy to write extremely bearish news stories – it always gets readers' attention far more than a bullish one. Indeed, a bear-market story tends to strike the greatest chord, partly because investors with capital already in the market only ever really want to hear positive things.
That said, as the ability to short the market (to profit from falling share prices) is now available to the everyday investor, short-term setbacks and volatility can be a good thing for some market participants.
In fairness, the bear case is often supported by a strong, logical arguments. The overvaluation of the US market and the potential for a setback, for example, has been commented on more times than I have had hot dinners.
There is substance to this argument – using Robert Shiller's cyclically adjusted price-to-earnings ratio (better known as the CAPE ratio), the US stock market looks overvalued. I can't argue with that, but I would say the market has looked almost consistently overvalued over the past 50 years, apart from only a handful of times when the market has looked lowly valued.
In other words, if you based your investment decisions purely on this valuation measure, you probably would have never invested in the US market and you would have missed out on returns from one of the strongest developed markets.
In reality, statistics on both sides of an argument are available for those wishing to take a specific stance.
Another similar theme at present is the so-called bond bubble. It is anticipated to burst upon the first interest rate shock, such as in 1994 when the US Federal Reserve doubled interest rates over a short period of time. This would not only cause a problem for bonds, but for equity markets also – even though it is hard to see much, if anything, of a rate rise in the near term given falling commodity prices and sluggish economic growth.
This relentless scepticism surrounding the markets has perhaps been bred from two dramatic 50 per cent stock market falls over the past decade. As such, many investors cannot help but constantly look over their shoulders in case something else might derail it once more.
The consequence is many savers remain unwilling to commit large amounts of cash to the market. This point is important as bull markets usually end when everyone is fully invested. That was certainly true of the 1987 stock market crash when there were few available buyers to invest in the stocks being rapidly sold. But today I see many participants willing the market to fall so they can actually invest.
I admit this is a dangerous article to write, which may come back to haunt me. We are approaching September and October – the hurricane season – which have historically been poor months for stock markets. However, I am heartened by this from renowned investor Peter Lynch: "Whatever method you use, your success or failure will depend on your ability to ignore worries of the world long enough."
In reality, I have no more idea of what might happen next to stock markets than anybody else. My suggestion would be to maintain a well-spread and diversified portfolio, alongside a good grounding of cash.
It may sound clichéd, but cash is vital for a rainy day and can also be used to top up favoured holdings during periods of market weakness.
Rather than constantly attempting to rejig your portfolio each time you hear about another wider economic issue, perhaps your time would be better spent on your favourite hobby or pastime.
After all, masterly inactivity is usually the best policy.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds in this column, visit www.hl.co.ukReuse content