Managing Director, Worldwide Financial Planning, writes:
I was asked quite recently about how difficult investing money can be, given the current market conditions and how investors must be feeling. I was also asked at what point I believed the market would turn.
Answer: Anyone can fly a plane in normal conditions. These conditions are extreme and it is in such times that a cool head has to be kept by all. This however, is also true in a rising market when we are close to the peak, and readers of this column will be all too aware of the fact that we told everyone to bail out of over heated property, as much as three years ago.
To know is to understand, so I will explain the basics of investor psychology for you.
January 2002, I was live on a BBC radio show with more dark hair than I have now, and was asked when we would hit the bottom (a customer had been advised they were at the bottom). I explained we were at the bottom when prices hit their all time lows in terms of price earnings ratios, and were considered ‘just too cheap’.
That point was 3287 in the FTSE when the market at 2002 was 5950. It is the point in the process when you have distressed sellers but also savvy investors. I believe we are pretty close to that now.
Let’s look closer at the psychology behind the investment process: We typically start with an investor who is unhappy with what they have. That investor moves through the early stages of doubt, suspicion, caution and confidence before enthusiasm, conviction and greed kick in. Unfortunately most of the growth has gone by the time confidence arrives. The market peaks at the point where we are greedy, and the entire pub has ‘one’. Normally a sign to exit stage right.
Everyone was becoming a buy to let investor, the biggest iceberg you will ever see, and that should have been a clear message. It wasn’t, and many ignored the obvious.
On the downturn of investor psychology we peak at greed and then all flows south so we have indifference, dismissal, denial (don’t open your valuations), fear, panic and then capitulation.
Judging by the questions I receive from the personal finance websites, we are indeed at that point of panic selling and capitulation.
I still think there will be some fierce problems when hedge funds are forced to sell their assets to pay for their ‘bets gone wrong’.
Hedge funds (to simplify) have a range of assets they invest into. They buy equities (called going long) and they also bet on contracts for differences (CFDs). These bets could be on a stock going up or indeed down and the return to the hedge fund is a multiple of the price movement.
If they get it wrong, the return could be a multiple loss. Many of the hedge funds have made some bad bets and they will soon be coming to closure. When they do, it’s likely they will go bust as they may not have the money to pay the debt off.
Meanwhile they will be forced to sell their equities to try and repay the debts. All this does is force the market down further as investors are net sellers of equities.
It’s a one-way spiral until capitulation. It is very possible when they start to repay these bets that markets may have to close to avoid panic selling, but that will be a sure fire trigger you are close to the bottom. In other words bad news is good news.
Regretfully you will not receive a text message, so selling now if you are in the market and trying to time re-entry is not a good option. Remember whilst we are at the end of the downward gloom the upward psychology begins again.
If you have an investment query call Peter on 0800 0112825 or e-mail info@wwfp.net
Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. ‘The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.’ Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. The above represents the personal opinions of Peter McGahan. All information is based on our understanding of current tax practices, which are subject to change.
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