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The perversities of investment

06 May 2014  |  Portfolio

 confusingThe past is of course a poor guide to the future of investment markets. But it takes a brave investor to shake off the pessimism created by previous bad periods. It is part of the perversity of markets, which do not behave rationally. That is because people are not rational.

The rational thing to do is to take advantage of weakness. So a period when everything seems terrible is precisely the time to jump in. When things are booming it is time to take profits. But in fact it works the other way round. In bad periods investors switch off. In good times they think they had better buy otherwise they will miss out.

The AFR suggests that the gloom in the wake of the GFC has gone too far:

"The global financial crisis inflicted severe financial and psychological damage on many investors, bankers, traders and salespeople.


But has the wave of pessimism gone too far? The Dow Jones reached a record high last week but no one seemed that happy about it.

Investors have become so accustomed to bad news that perhaps when good news does turn up they don’t know what to do.

If that’s true, markets could really take off when good news does emerge as it catches everyone on the hop, while at the same time bad news might get shrugged aside as everyone was expecting it, or at the very least is so used to it by now and so it has a limited impact.

The exact opposite happened in 2007 when sharemarkets were on a tear and a few wise heads worried that after four fantastic years for shares, young traders only knew markets that went up in a straight line all the time.

Fast-forward to today and there is a sense of foreboding as everyone complains there are no bargains left in the sharemarket despite valuations that, by historical standards, aren’t that stretched.

Likewise, global interest rates are at record lows and bond yields at ultra-lows are not very attractive or creating exciting investment opportunities.

On cue, there are the calls right now for the “sell in May and go away” strategy."

The global indications do not look overly bearish. The US is showing signs of recovery. The US Federal Reserve is likely to raise interest rates in the next year or so, and Japan and Europe seem to be dealing with deflation. China continues to grow at an extraordinary rate. There are positive signs in the American labour market and service sector, although US GDP growth figures are still weak. 

The AFR suggests that investors are becoming complacent, not really responding to anything:

"Since February the S&P 500 has traded in its tightest range since February 2007, oil has moved between $US100 and $US110 a barrel over the past year.

Investors have to go back almost 30 years to find a similar range. Volatility in currency and share markets is also very low.

Late last month Deutsche Bank’s volatility index, based on three-month options for nine major currency pairs, dropped 25 basis points to 6.24 per cent, the lowest since July 2007."

The effect of the GFC remains.


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