How falling markets present tough questions to investors

Thursday, Oct 25 2018 by
44
How falling markets present tough questions to investors

Share prices have fallen across the board in October, and it’s a reminder of just how quickly fear spreads when stocks start tumbling. My colleague Jack wrote this week about the sense of foreboding that’s hanging in the air at the moment. There’s almost a sense of inevitability that some kind of correction is past due. Knowing how to react to that kind of prospect is difficult.

Ten years into a bull run, and faced with various signs of trouble (in various parts of the world), it’s not hard to piece together a pretty gloomy narrative. While October has been unpleasant, some of the main UK indices - certainly the small and mid-caps - have been trending down since early summer. So for some investors, this experience has been less of a suckerpunch correction and more of a protracted beating.

This week the FTSE 250 has been flirting with correction territory, with the index currently down by just over nine percent for the month. As usual, the UK indices are taking at least some of their cues from price action in the United States. That’s been translating into some sharp and unpredictable intraday moves - days that start well but end up finishing on yet another low.

Profit warnings and bad news

In recent weeks the sharpest falls on the FTSE 250 have been exacerbated by bad news and profit warnings. Among the biggest fallers have been stocks like Keller, ConvaTec, Superdry, Indivior, Inchcape and Victrex. In terms of relative price strength, they’ve all undershot the All-Share index by more than 20 percent.

There are similar war stories over on the AIM All-Share, where Fevertree Drinks - a stock that, size-wise, has more in common with the FTSE 100, has seen more than a billion pounds wiped off its value since the end of the summer. It’s down from £4.23bn in early September to £3.18bn currently.

But it isn’t necessarily all bad news. It’s fair to say that some stocks (a minority) are holding up reasonably well under the conditions. But it’s also the case that investors with at least half an eye on value have been crying out for a meaningful correction for several years. For many, what we’ve seen so far won’t be anywhere near enough. As a result, we’ve…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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73 Comments on this Article show/hide all

Howard Adams 27th Oct '18 34 of 73
4

In reply to post #412764

Hi BH

With reference to your point ....

'Have you read Mark Minervini's books? Even if you don't wish to trend follow like he does, the chapters on risk management are truly eye opening. It changed my approach and I'm now profitable as a result. The books are only c.£20-£25 on Amazon. Quite possibly the best investment I have ever made haha!'

I totally concur with your sentiment. I have employed Minervini's risk management advice pretty rigorously since reading it last November. I can say without question not only has it protected my portfolio very well but it has really helped me to become more confident with my investing.

Regards

Howard

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Howard Adams 27th Oct '18 35 of 73
2

In reply to post #412774

Hi Phil

Excellent post, thank you.

Regards
Howard

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Nick Ray 27th Oct '18 36 of 73
2

In reply to post #412769

The argument that markets are efficient was blown out of the water decades ago by the likes of George Sros probably the best of market timers

The Nobel prize for economics in 2013 went to Fama, Hansen and Shiller. Fama and Hansen developed much of the theory behind efficient markets and Shiller did a lot of work on understanding when markets are not efficient. (Shiller's book "Irrational Exuberance" is a great read by the way. Highly recommended.)

But I wouldn't say that Shiller's work invalidates the work of Fama and Hansen. It just takes things forward.

The work by Fernholz on Stochastic Portfolio Theory gives another perspective in how to develop the theory which I think has a few ideas worth following.

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Hot Socks 28th Oct '18 37 of 73
2

In reply to post #412289

Victrex has had similar falls to XP Power and Renishaw (I hold all three ). They are all industrials and very sensitive to growth. In the case of Victrex to smart phones and consumer electronics in particular. They also all have activities in the Far East including manufacturing plants. So news of slowing Chinese growth, friction over trade and tariffs has probably caused a rethink of their valuations. They had all benefitted from currency headwinds due to the fall in the pound following the Brexit referendums and were on pretty racy valuations. I'm not surprised that they have fallen so sharply, the valuations for all three are now at a more rational level.

I don't share your sense of depression at all. I think the question to ask is whether to employ a market timing/trading based strategy. there are perfectly good reasons to decide not to (some referred to in the other comments in this thread) and having made the decision not to you have to stick with that and not lose sleep over it.

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Hot Socks 28th Oct '18 38 of 73
3

In reply to post #412764

"A quality company does not always mean a quality investment. Regardless of what others think, price is king and where you enter and exit a stock will have a significant impact on your portfolio returns."

I agree with this to some extent but I think precisely how far it is true depends on your outlook and what you are trying to achieve. The best analogy I can come up with is buying a house. If you are going to sell it in two years time then the price you pay for it may have a huge impact on whether or not you make any money. If you own the house for 40 years then the interest on the mortgage, 40 years of inflation, the cost of maintenance and repairs etc will all add up to making the price you paid for it pretty much irrelevant. far more important to any returns will be whether it is a nice house in a good location. with the 40 year time horizon the really big risks are buying a bad house or in not buying a house because you are so worried about overpaying you fail to do anything.

The same I think is true with a business. If you are invested long term the risks in buying a bad business or in suffering inferior returns on cash appear to be much greater than the risk of overpaying.

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daverawc 28th Oct '18 39 of 73

In reply to post #412819

Like Jim Rogers has said numerous times in interviews, if the efficient market hypothesis is correct it not have been possible for him or Soros to have made the outsize gains that are on record.
He practices the academics preach.

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daverawc 28th Oct '18 40 of 73
1

apologies my typing and grammar are terrible

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underscored 28th Oct '18 41 of 73
2

In reply to post #412944

Does the hypothesis have to be totally right or totally wrong? it seems to be a reasonable starting point for thinking about how markets work, if not the final absolute truth.

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timarr 28th Oct '18 42 of 73
8

In reply to post #412944

Like Jim Rogers has said numerous times in interviews, if the efficient market hypothesis is correct it not have been possible for him or Soros to have made the outsize gains that are on record.

But Jim Rogers and George Soros are the exceptions, not the rule. I can kick a football but I wouldn't ever compare myself to Lionel Messi. A more interesting question would be, if the EMH isn't correct why can't the average investor beat the index? And the corollary to that is: if the average investor can't beat the index how come there are a small number of people like Soros and Rogers who can?

To understand the answer to that you need to understand a bit about the assumptions behind the EMH - mainly that all information is assimilated by markets and is in the current price. If that's correct then the only way to beat the market would be to have access to inside information.

However, behind that assumption is the key problem in economics - that human beings are perfectly efficient processors of information. But we're not - we have limited processing power and over millions of years of evolution we've developed heuristics - short-cuts - to overcome these. And while these work well in most everyday situations they also mean we don't assimilate all information immediately and make mistakes in processing.

We call these errors biases. For example, we assume tomorrow will be like today (we anchor on prices, we project current market conditions infinitely into the future), we look for information that confirms our understanding rather than that which disconfirms it (confirmation bias), we look for leaders to follow rather than thinking for ourselves (deferral to authority), we try to find things that give us pleasure and avoid things that give us pain (loss aversion where we keep losers and sell winners, and the disposition effect), etc, etc.

What's interesting about Soros and Rodgers and Buffett and the other handful of people who are able to overcome the limitations of the EMH is that they don't suffer from these biases in the way that most of us do. However, they do all suffer from a delusion common to everyone else - that their experiences of the world are equivalent to everyone else's (technically, the introspection illusion) - so they go around telling everyone that their example is something anyone can follow.

But they're wrong. Most people can't. For most people the EMH is real - apart from when the market departs from efficiency (which it does with surprising frequency). But that's another story entirely.

timarr

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skinner66 28th Oct '18 43 of 73
3

hot socks, sorry disagree i sold my other house after renting it out, for what i spent to maintain i still was big profit, or why would i rent it out,, then i sold at 100k profit,,

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aflash 28th Oct '18 44 of 73
4

'Where I do think I excel is in recognizing my mistakes...that is the secret to my success'

Why the inverted commas? George Soros wrote it, not me.

'I came to the conclusion that basically all our views of the world are somehow flawed or distorted and I then concentrated on the importance of this distortion in shaping events'

'The big difference between Jim Rogers and me was that Jim thought that the prevailing view was always wrong, whereas I thought that we may be wrong also.'

Who acknowledges that they are fallible while buy and selling? I do. Soros does.

This is a good thread. If we get on to reflexivity it will be an excellent one. Here is Soros again:

'Only the first part of my argument - that the prevailing bias affects market prices - seems to have registered. The second part - that the prevailing bias can, in certain circumstancs, also affect the so called fundamentals and changes in market prices cause changes in market prices- seems to have gone unnoticed.


Not by me. How about you?

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Nursemaid 28th Oct '18 45 of 73
2

In reply to post #412774

Excellent post Phil H., thanks for sharing.

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mmarkkj777 29th Oct '18 46 of 73
2

Great post and interesting replies.

I'm 95% in cash now. I didn't need to make the decision. All my stop losses triggered (bar a couple) over the last 3 weeks. Mostly auto, but manually controlled on my American stocks. I now just hold 3 large blue chips that I have had for years and will probably stick with. I need to time my re-entry so as not to miss the upside, as mentioned in posts above. Time will tell if this was the better approach or not (last time I stayed in). I'll probably go for Value showing early momentum, as opposed to growth, when I initially start to go back in.

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timarr 29th Oct '18 47 of 73
4

In reply to post #412994

This is a good thread. If we get on to reflexivity it will be an excellent one.

Something like this: Soros' Economic Reflexivity?
So [in standard economics] if a security falls in price below its fundamental value then traders will purchase it and bid its price up until it reaches the equilibrium point again. With economic reflexivity this may not happen: if traders believe markets are about to fall they’ll sell – and markets will fall. Sometimes lots of traders will do this, become convinced they're right and carry on selling (or buying). Standard economics calls this irrational, Soros thinks it's reflexivity in action because the act of selling, or buying, changes the mental expectations of people.
Basically, markets can become irrational for long periods, even though the behaviour of investors is perfectly rational by their own standards.

timarr

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gus 1065 29th Oct '18 48 of 73
2

In reply to post #413034

... and sadly, as JM Keynes pointed out, the markets can remain irrational for longer than many of us can remain solvent (especially if using leverage).

Gus.

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timarr 29th Oct '18 49 of 73
1

In reply to post #413074

and sadly, as JM Keynes pointed out, the markets can remain irrational for longer than many of us can remain solvent (especially if using leverage)

Apparently he didn't say that - at least no one can find the source of the quote. But he did create the concept of the beauty contest as applied to investing in which everyone bets on the person they think everyone else will want to win, rather than the person they think is the most handsome.

There's a really interesting paper by David Chambers and Elroy Dimson that charts Keynes' evolution from an unsuccessful top down macro-economic led investor to a successful bottom up fundamentals led one. It mirrors the experience of many people and the research which suggests that more experienced investors are less biased and trade less:

Keynes the Stockmarket Investor

timarr

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gus 1065 29th Oct '18 50 of 73
1

In reply to post #413089

Hi timer.

Fair comment. JMK said a lot of things but in this case it’s hard to stick that particular tail on the donkey. The attached link attempts to explain the attribution.

https://quoteinvestigator.com/2011/08/09/remain-solvent/

Gus.

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mmarkkj777 29th Oct '18 51 of 73
3

I guess, regardless of the theory and who defined it, we are essentially talking about market sentiment, collective behaviour of share holders, rather than intrinsic economic value. Who was it who said they will 'revert to the mean' eventually.

I honestly don't know whether I am acting or re-acting. All I know is that I feel better in my self for being mainly out of the market at the moment, which is probably a good thing for decision making overall. It also means I have the capital to reinvest when I think the time is right. The big question is, will my opportunity loss (if I get the timing wrong) be greater than the loss I would have incurred by remaining fully invested. Only time will tell.

I'm sure there are many more with the same situation.

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Hot Socks 29th Oct '18 52 of 73

In reply to post #412974

which bit did you disagree with?

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Tradertimes82 31st Oct '18 53 of 73

Just read this article this morning (31/10/18), it couldn't be more apt! As a self taught (not a good idea, but who do you trust? ) novice who has largely traded in the AIM market and two years into trading, this last couple of days has seen my portfolio and my frame of mind hit rock bottom, it's ironic this should appear in my inbox today. Read this, take it in and remember it folks. I guess trading isn't for me.

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