Secrets Of Success: Chill out; equities are always volatile

So far, so good. It seems that the markets have started to restabilise quite nicely after the excitements of the week before last.

As usual, those who have suffered most from the gyrations are those with leveraged or trading positions. Anyone with a geared long position has had to scramble to protect themselves (although there will be others on the other side of the trades, albeit a much smaller number, who will be licking their lips with satisfaction at the turn of events).

The latest episode serves to remind us of some important lessons of equity investment. One is that the risk of equities as a class does not change from year to year. They have always been volatile; and if you are uncomfortable with seeing the value of your portfolio fall by 3.5 per cent in a day, which will happen from time to time, you should not be owning equities in the first place.

Second, watching the market every day (as anyone now can do, thanks to technology and the power of the internet) is a mixed blessing. By accentuating the apparent volatility of the market, having the value of your investments marked to market every minute of the day tends to feed all the irrational and emotional impulses that make human beings less than perfect investors.

It will be interesting to see, in this context, whether real estate investment trusts (Reits) change the attitude of investors towards the attractions of commercial property. As they are quoted companies, with prices listed every day, the price of Reits appears to fluctuate more dramatically than conventional commercial property funds, even though the assets they hold may be more or less identical. Perceived risk, in other words, can differ from intrinsic risk purely as a function of whether something is a traded security or not.

The news media, it has to be said, being naturally attuned to reporting on daily rather than longer-term events, does not help much in this regard. You may have noticed a third phenomenon about market wobbles, which is that suddenly the news is full of negative items, whereas in bullish phases the same events will be downplayed or ignored.

The reality is that the fundamental forces to which the financial markets must ultimately respond move very slowly in comparison to the markets themselves. Worries about the sub-prime mortgage lending market, to take one topical example, are hardly new. They have been exercising many professional market commentators for some time. The problems at HSBC, which chose to become one of the big players in this market through acquisition, did not suddenly appear overnight.

The difference is that, in the light of a sudden market move, such concerns move from being one of a million potential market-moving factors to the first immediate explanation. On this point, I cannot do better than quote Professor Jeremy Siegel, the celebrated market egghead from Wharton University of Pennsylvania and author of Stocks for the Long Run and other such books.

"Individuals," Professor Siegel tells us, "have a deep psychological need to find fundamental explanations for why the market is doing what it is doing. It is very discomforting for many to learn that most movements in the market are random and do not have any identifiable cause or reason. Most investors find comfort when someone explains to them 'why', even though on further thought they often know that the explanation given is unlikely to be the true cause of market moves."

So, for example, if you are seriously worried about the sub-prime mortgage lending market in the United States, it's worth pointing out that it accounts for a truly tiny percentage of the $10 trillion mortgage lending market in that country. While what is happening in that market may be a symptom of deteriorating credit conditions, it is hardly going to bring financial markets crashing to their knees.

While stock markets are inherently volatile, they do go through patches when all the movement appears to be one way. Such phases of positive momentum, when prices rise apparently without pause week after week, always draw in new buyers and bring their own dangers. The longer such momentum markets continue, the more likely they are to be interrupted by a sudden break of the kind we have just witnessed.

The final point, of course, is that markets cannot escape the pull of valuations. The more they rise, the more expensive (other things being equal) they become. At some point, they have to run out of road and revert to more normal levels. Unless capitalism has been suspended altogether, there is a finite limit to how high profit margins and corporate earnings can rise.

One appealing argument for the strength of real estate and most financial markets in the past few years is that the spread of globalisation, coupled with the effective control of inflation, has produced a one-off change in the ability of the world financial system to spread the risk of owning investment assets, to the benefit of all of us. That might justify investors paying a lower premium for risk than in the past. But how much more secure are we as a result? Somewhere along the way, amid the day-to-day market turbulence, we will in due course find out the answer.

* Bill Mott, the veteran income-fund manager, is returning to full-time money management at a new boutique, Psigma. Meanwhile, his former employer, Credit Suisse Asset Management, seems to be imploding, having lost virtually all its top fund managers in the course of the last year (the most recent defection coming this week with the departure of its multi- manager team to Thames River Capital).

Dr Mott is a class act, so unless his sabbatical has dulled his appetite, consider adding his new fund, when it opens, to your list of possibles for next year.

jd@independent-investor.com

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

News
In 2006, Pluto was reclassified as a 'dwarf planet'
scienceBut will it be reinstated?
News
Jennifer Lawrence at the Vanity Fair Academy Awards party in February 2014
people12 undisclosed female victims are seeking $100m in damages
Arts and Entertainment
Adam Levine plays a butcher who obsessively stalks a woman in Maroon 5's 'Animals' music video
music'Animals' video 'promotes sexual violence against women'
News
people Biographer says cinema’s enduring sex symbol led a secret troubled life
PROMOTED VIDEO
Voices
voicesI like surprises - that's why I'm bringing them back to politics, writes Nigel Farage
News
Bear and hare woodland scene from John Lewis Christmas advert
newsRetailer breaks with tradition, selling real festive fir trees online for the first time
Arts and Entertainment
Anthony Horowitz will write the next 007 novel
booksAnthony Horowitz to write new instalment in spy series for 2015
News
British actor Idris Elba is also a DJ and rapper who played Ibiza last summer
people
News
people

Kirstie Allsopp has waded into the female fertility debate again

Sport
Kicking on: Nathaniel Clyne is relishing the challenge of the Premier League after moving from Crystal Palace
footballSurprises include a first ever call-up for one Southampton star
Voices
4 May 2013: The sun rises over Tower Bridge in London. Temperatures across the UK could be higher than several European holiday destinations by Monday, including parts of Italy and France (Andy Hepburn/PA)
voices
News
The moon observed in visible light, topography and the GRAIL gravity gradients
science

...and it wasn't caused by an asteroid crash, as first thought

News
Researchers say a diet of fatty foods could impede smell abilities
scienceMeasuring the sense may predict a person's lifespan
News
newsGlobal index has ranked the quality of life for OAPs - but the UK didn't even make it into the top 10
Extras
indybest
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Trainee Recruitment Consultant - Birmingham - Real Staffing

    £18000 - £23000 per annum + Commission: SThree: Real Staffing are currently lo...

    Trust Accountant - Kent

    NEGOTIABLE: Austen Lloyd: TRUST ACCOUNTANT - KENTIf you are a Chartered Accou...

    Graduate Recruitment Consultant - 2013/14 Grads - No Exp Needed

    £18000 - £20000 per annum + OTE £30000: SThree: SThree are a global FTSE 250 b...

    Law Costs

    Highly Competitive Salary: Austen Lloyd: CITY - Law Costs Draftsperson - NICHE...

    Day In a Page

    Italian couples fake UK divorce scam on an ‘industrial scale’

    Welcome to Maidenhead, the divorce capital of... Italy

    A look at the the legal tourists who exploited our liberal dissolution rules
    Tom and Jerry cartoons now carry a 'racial prejudice' warning on Amazon

    Tom and Jerry cartoons now carry a 'racial prejudice' warning on Amazon

    The vintage series has often been criticised for racial stereotyping
    An app for the amorous: Could Good2Go end disputes about sexual consent - without being a passion-killer?

    An app for the amorous

    Could Good2Go end disputes about sexual consent - without being a passion-killer?
    Llansanffraid is now Llansantffraid. Welsh town changes its name, but can you spot the difference?

    Llansanffraid is now Llansantffraid

    Welsh town changes its name, but can you spot the difference?
    Charlotte Riley: At the peak of her powers

    Charlotte Riley: At the peak of her powers

    After a few early missteps with Chekhov, her acting career has taken her to Hollywood. Next up is a role in the BBC’s gangster drama ‘Peaky Blinders’
    She's having a laugh: Britain's female comedians have never had it so good

    She's having a laugh

    Britain's female comedians have never had it so good, says stand-up Natalie Haynes
    Sistine Chapel to ‘sing’ with new LED lights designed to bring Michelangelo’s masterpiece out of the shadows

    Let there be light

    Sistine Chapel to ‘sing’ with new LEDs designed to bring Michelangelo’s masterpiece out of the shadows
    Great British Bake Off, semi-final, review: Richard remains the baker to beat

    Tensions rise in Bake Off's pastry week

    Richard remains the baker to beat as Chetna begins to flake
    Paris Fashion Week, spring/summer 2015: Time travel fashion at Louis Vuitton in Paris

    A look to the future

    It's time travel fashion at Louis Vuitton in Paris
    The 10 best bedspreads

    The 10 best bedspreads

    Before you up the tog count on your duvet, add an extra layer and a room-changing piece to your bed this autumn
    Arsenal vs Galatasaray: Five things we learnt from the Emirates

    Arsenal vs Galatasaray

    Five things we learnt from the Gunners' Champions League victory at the Emirates
    Stuart Lancaster’s long-term deal makes sense – a rarity for a decision taken by the RFU

    Lancaster’s long-term deal makes sense – a rarity for a decision taken by the RFU

    This deal gives England a head-start to prepare for 2019 World Cup, says Chris Hewett
    Ebola outbreak: The children orphaned by the virus – then rejected by surviving relatives over fear of infection

    The children orphaned by Ebola...

    ... then rejected by surviving relatives over fear of infection
    Pride: Are censors pandering to homophobia?

    Are censors pandering to homophobia?

    US film censors have ruled 'Pride' unfit for under-16s, though it contains no sex or violence
    The magic of roundabouts

    Lords of the rings

    Just who are the Roundabout Appreciation Society?