Stock market falls: what caused them and a plan of action

Investors could be forgiven for feeling nervous after the events of the past few weeks. Stock markets across the world nosedived, following a relatively benign summer; the UK’s FTSE 100 index is down 6% so far in October, while the S&P 500 has fallen 5.5% in sterling terms.*

There are a number of reasons behind this market weakness. Firstly, government bond markets around the globe have come under pressure on the back of concerns that US interest rates could rise too quickly. This has caused Treasury (US government bond) prices to fall and yields to rise, as the two move inverse to each other. For example, 10-year Treasury yields reached 3.23% in early October - their highest level since 2011.** In turn, this caused gilt yields to rise to 1.72%, representing a two-year high.^

You can then throw in growing tensions between the US and Saudi Arabia, which has implications for the oil price, as well as the US’s ongoing trade war with China. Closer to home uncertainty surrounds the UK’s exit from the European Union (EU) next March, while Italy’s budget plans have exposed tensions between the country’s coalition government and the EU.

The million dollar question is whether the market weakness we have experienced so far in October marks the start of a prolonged downturn, or is it simply a short-term wobble? Although it is too early to answer this question, there are a number of factors to bear in mind when it comes to deciding how to respond to market movements:

1) What is your investment timeframe?

If your timeframe is short (i.e. you are approaching retirement) and you have made healthy profits over the past five to 10 years, you may consider moving into lower risk assets and cash soon.

If your timeframe is longer – for example, 10 years plus – it could make sense to stay invested but have a fair allocation to cash (perhaps between 10% and 20%). This will allow you to invest opportunistically if markets take another leg down. History shows time and time again that it is very difficult to time markets, so I would suggest staying focused on the long-term case for your investments; try to look beyond the short-term turbulence.

2) How are markets valued?

If we take the US as an example, a number of metrics indicate that equity valuations look expensive relative to history. The Shiller cyclically-adjusted price-to-earnings ratio for the S&P 500, which measures whether the market looks cheap or expensive relative to history, finished the third quarter at 33.2x. This compares to an average of 25.7x since 1990.^^ When valuations start to look expensive, history shows that significant market falls can happen, particularly during a late stage in the economic cycle. 

Think about the long-term income or growth potential of the investments you hold and whether they are priced accordingly. Another point to stress here is that it is notoriously difficult to time markets, so don’t forget to keep one eye fixed on the long-term.

3) Don’t panic!

This is one of the most important things to remember when markets go into free-fall. It will help you to avoid making rash decisions during times of market stress. For example, selling out at the bottom of the market and crystallising a loss. Think about whether your portfolio matches your risk tolerance and try to monitor this on an ongoing basis. It will allow you to avoid feeling undue stress if markets come under pressure.

Here are three funds that have the potential to deliver - even if market volatility continues:

• Church House Tenax Absolute Return Strategies – This multi-asset fund has a strong track record of achieving a positive return, regardless of what the market throws at it. The investment team, comprising of James Mahon and Jeremy Wharton, do this by diversifying the portfolio and managing risk closely.
• Henderson UK Absolute Return - The managers of this fund look to identify stocks that will either exceed, or fall short of, analysts' expectations, and construct a portfolio of both long positions (so they profit when the share price goes up) and short positions (so they also profit when the share price goes down).
• Jupiter Absolute Return – This fund has a low historic correlation to other asset classes. Manager James Clunie is able to short stocks around the world, which allows him to make money when share prices fall. This strategy is an effective diversifier and has the potential to perform well in spite of market volatility.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius' views are his own and do not constitute financial advice.

* Source: FE Analytics, total returns in sterling 1 October to 18 October 2018

** Source: Bloomberg, data as at 8 October 2018

^ Source: Bloomberg, data as at 10 October 2018

^^Source: JP Morgan Asset Management, Q4 Guide to Markets, as at 30 September 2018