Investment Strategies

How to profit from falling markets

When markets fall, how do you profit?

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Strategies for market turmoil

No one would disagree that the equity markets around the world are having a difficult time (Written 29th September 2008) . The credit crisis, price of commodities, inflation and several other factors are happening at the same time and this makes for difficult stock market conditions. In these circumstances, emotion often takes hold of investors decision making and leads to decisions in the short term that appear to reduce the fear or disappointment factor. Often, however, these decisions are later regretted and are often expensive for the individual. Here are two strategies that have served our clients well in the past (having been in this job for 23 years and having seen several such stock market periods) and which could benefit you during any period of uncertainty.

Current Investments Strategy

In 1973 markets fell by 25% and then in 1974 a further 50%. But in 1975 prices doubled in 3 months. Black Monday - October 1987 - markets fell 22% in one day. But by the 31st December 1987 the markets had bounced so that the return for the year of 1987 was +4%, yes + 4%. More recently, with the bursting of the tech bubble and 9/11, markets fell 50%. But share prices climbed again in 2003 by 30%. From 2004 to 2007 they climbed a further 50%.

The lesson from this is that there are often significant rebounds after severe corrections. This is because markets often become oversold and at the end of a correction there is a period known as "capitulation". Often this is caused by people eventually throwing in the towel and selling their investments. In the current market, capitulation is likely to be when the companies that have overstretched themselves will go bust. Bradford & Bingley in the UK is the most recent example but Northern Rock, Bear Stearns, Lehman, AIG, Fortis, XL, Washington Mutual are other well known examples. Less well known examples are also happening out of the main spotlight including other banks in Europe, retailers and construction companies. We await the fate of several other banks and other consumer based businesses. After the "flushing out" of these companies perhaps we will start to see the turnaround.

The issue is that nobody knows for certain when this rebound will occur and how much of a rebound we will get. We will be only be able to know this after the event. But research from Fidelity group, which has been repeated for several years now, is instructive and shows that if we had invested £10,000 in the FTSE in June 1992 and left it until June 2007 (the date of the last survey) our £10,000 would have grown to £46,120. BUT if we had missed the 10 best trading days (because we had taken our money out of the market) we would only have 30,410. A whopping difference of £15,710 less. And if we missed the best 15 days the difference would be a staggering £24,000 less. In terms of risk, one of the biggest risks is therefore to be out of the market. The best strategy for your investments is actually to keep them in the market EVEN during times like these.

Making Money Strategy

If you want to improve the performance of your investments there is another great strategy which has helped many investors, including the likes of Sir John Templeton. Sir John was a contrarian investment. He started his career by buying 100 shares in 104 companies. 34 of these companies were in bankruptcy. He lost money on 4 of the companies but the others started him on a career that made him a billionaire. He had 5 steps to financial success.

Take calculated risks

Save Don't Spend

Shop for value investments

Take advantage of international free markets

Minimise your taxes

Personally, I agree wholeheartly with these steps and I am sure you will be able to see that in difficult markets it is possible to use these steps. Of course, we want to know how to take a calculated risk. Here is some very important information that will help you calculate the risk. The Barclays Capital Equity Gilt Study has been undertaken annually for many years. It still shows that equity (shares) investments outperform cash (money in the bank) in the following ways: Over any 3 year period shares outperform 71% of the time. Over any 10 year period shares outperform 93% of the time. Furthermore, over the long term shares have exceeded inflation by 6.7% per annum ie inflation + 6.7%. So what strategy to adopt? When the stock markets are way below these figures from the Barclays study it is more likely that you will profit well when the markets return to their average returns. This is true of both the 3 year figures and for the inflation plus 6.7% this year. For someone who wans to take a calculated risk, invest for the medium term and follow Sir John's steps to financial success the best strategy could be investing now!

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Barry Davys MBA Dip PFS
Expat Financial Advice Spain

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