Investors often make less money than broad stock market gains would have us believe.
Emotions are a major cause. Some become sufficiently emboldened to top up their investment funds only months after a rally begins. Their gains tend to lag behind market indices for this reason. Anecdotal evidence suggests that others get nervous and shift to cash in the late stage of sharp sell-offs, completely missing the bounce-back rally.
The current downturn is a good example of the kind of stock market in which this can happen. At the low point last Tuesday evening, the indices had fallen 15 per cent below mid-April’s peak. Some nervous investors were shaken out. Others were spooked by huge volatility and are unlikely to re-invest sidelined cash until their confidence returns.
Scary news headlines contribute to this problem. For this reason, I try hard to ignore them when planning my own trading strategy. But it can be difficult to do when screaming headlines are full of doom – and we are currently in the midst of such a fear cycle. Recent statements by the European Central Bank and Germany’s Chancellor suggest a strong whiff of panic. Daily reports about steep stock-market declines are also frightening. Here at home, the chancellor and the Queen have both reminded us that the “age of austerity” is under way.
However, in spite of all this bad news, I committed 100 per cent of my short-term trading funds to shares early last week.
Some readers may regard my decision as irrational. It is to be hoped they will be wrong.
Several factors encourage me to turn so positive. One is my deep-seated belief that today’s headlines only explain why shares fell yesterday – not what they will do tomorrow. I also believe that the full extent of the European financial crisis is out in the open. European leaders are obviously frightened and are now considering necessary actions that were off the table a few weeks ago. Obviously, a fresh crisis that no one has yet even dreamt about could make me expensively wrong. This is my nightmare scenario. But recent headlines about Greece, Portugal, European economic sluggishness or potential knock-on effects in the US do not trouble me – because I believe these fears are already in the price.
The chart (above) makes another upbeat point. Notice that several recent FTSE 100 sell-offs ended in the 5000 area. There are no guarantees for the future, of course, but I was heartened by last week’s sharp rebound from this support area.
A 15 per cent decline since the stock market peaked last month also gives me comfort. This is a sizeable drop. Even if further falls are in the pipeline, I suspect that much of the damage has already been done and further pain will probably be minimal.
Although I am positive about near-term prospects, one share that I shall continue to avoid is oil giant BP. I know little about the technical aspects of the Gulf of Mexico spill but the company’s post-spill behaviour has the look and feel of a very long-running disaster. I worry that the shares will decline further.
BP already had a poor safety image in the US. Last month’s spill seriously worsened its reputation. The company did everything disaster management experts advise corporations not to do. It stonewalled the media and the government, blamed others, repeatedly tried to minimise the extent of the leak and blocked indepen-dent assessments. Its chairman even lectured us last week about how important BP was to the US economy.
The US public is now anti-BP and politicians are quick to take advantage of this situation by piling blame directly onto the company. I fear the impact on the share price could be greater than current estimates suggest. Well-capping success may trigger a short-term bounce. But bad news from the courts will continue for a long time. I also worry that new US drilling authorisations will be few and far between in the years ahead.
In my view, BP is disaster-prone. Significant senior staff changes in areas of production, safety and public relations are required before these shares are safe to touch.
Stock market historian David Schwartz is an active short-term trader writing about his own trades and strategies. Send any comments or suggestions to email@example.com
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