Although volatility in equity markets is high, it may comfort you to know that it has been worse.
Fiscal View: In gloomy market times, times is still on market's side
The last time I wrote for this column, I was reporting on my remarkable achievements in assisting my son with his calculus homework and the even more remarkable performance of equity markets in October.
I wrote: "October has witnessed ... the largest monthly growth rate in equity markets for 21 years in the UK and for 37 years in the case of the US. With only one more trading day to go in October, the FTSE 100 index was up by an amazing 11.2 per cent for the month, finishing at 5,702 on Friday, October 28. The last time this kind of monthly performance occurred was more than 20 years ago, in May 1990, when the FTSE 100 index leapt 11.5 per cent."
Equity markets, clearly, were responding positively to strengthening data on US retail sales, improving economic growth in the US and growing hopes of a solution to the euro zone's debt crisis.
Well, it's all different now, isn't it? The current news is mainly of a gloomy nature and the FTSE 100, in sympathy, dropped 8.4 per cent to 5,223 on November 21 from its October high.
The euphoria subsided dramatically as European politicians, contrary to our initial hopes, failed to make much progress in raising the finances needed to support Greece and other profligate nations in the euro zone.
Markets also reacted unfavourably as various US government factions were unable to reach agreement on a programme to reduce the country's staggering debts. If this were not enough, inflation in the UK remains high - the Consumer Price Index (CPI) and the Retail Price Index (RPI) are 5 per cent and 5.4 per cent respectively. None of this is good news for equity markets.
But there are a few glimmers of hope on the horizon. Italy has a new non-partisan government that is in favour of budgetary reform. True, its new president is unlikely to generate as much entertaining news as Silvio Berlusconi, but I am sure that some enterprising politician somewhere in Italy will oblige, as they always do.
And Spain, reassuringly, shows signs of moving in a similar direction by taking closer charge of its budget. This is all very promising.
Although volatility in equity markets, as indicated above, is high, it may comfort you to know that it has been worse. It was much higher in 2008-2009, when global markets reeled in reaction to the credit crisis. Volatility was even slightly higher in 2002-2003, in the years following the dotcom crisis. To add more comfort (if you need it), the US and European equity markets are still above the low values they reached just a few months ago in the summer. In Europe's case, they are considerably higher.
Furthermore, while the US government is having difficulty solving its budgetary problems, economic activity perversely seems to be picking up. Retail sales, industrial production and employment are all improving, although not as fast as the rest of the world would like. Equity markets have always reacted instantaneously to snippets of news and, it seems, they are currently reacting more strongly to negative news than they are to positive news.
Well, as an investor, how should you respond to all this? Is it best to protect your portfolio against further downside movements or should you recognise this as a buying opportunity and increase your equity holdings while they are still relatively cheap?
The answer to this depends on your investment time horizon and your attitude to risk. If you have time on your side and are willing to live with the volatility, you should hang in there. If your financial needs are short term, then you should not have had too much exposure to equities in the first place, but, if you do, then I suggest that you hang in there for a while to recover some of your losses and reduce risk shortly afterwards.
In view of the relative cheapness of equities, it may be worthwhile increasing your holdings, but in which markets? Barclays Wealth suggests the US market offers the best risk-reward benefits in the developed world and expects corporations to continue producing good earnings growth.
It also says that corporate valuations in the European markets (excluding the UK) are among the most attractive in the developed world. Stocks have been punished by the euro zone sovereign-debt crisis and offer a number of investment opportunities. It recommends underweight positions in the UK and emerging markets, while it is neutral on Japan. With regard to other asset classes, it suggests reducing exposure to investment grade and government bonds and holding on to cash to take advantage of buying opportunities.
Barclays expects to see the traditional stock market rally by the end of the year - the so-called Santa rally. But before you start looking forward to this season of good will, bear in mind that there are still a few Scrooges out there who have a different view about what this time of year has to offer.
Bill Davey is a wealth manager at Mondial-Financial Partners in Dubai. Contact him at email@example.com.