There was a time when investing seemed quite straightforward, if that is ever possible. In days gone by, good economic news meant that most companies might do well because the outlook for businesses was more optimistic. A positive outlook could help to provide some certainty and clarity, which could translate into a cheery consensus for earnings. Lots can happen off the back of that. For instance, companies could be assigned a higher rating, which could then translate into a higher market value. Or put another way, a higher share price. Then along came Quantitative Easing, which turned logic on its…
There was a time when investing seemed quite straightforward, if that is ever possible.
In days gone by, good economic news meant that most companies might do well because the outlook for businesses was more optimistic. A positive outlook could help to provide some certainty and clarity, which could translate into a cheery consensus for earnings.
Lots can happen off the back of that. For instance, companies could be assigned a higher rating, which could then translate into a higher market value. Or put another way, a higher share price.
Then along came Quantitative Easing, which turned logic on its head, overnight. Quantitative Easing, which is still a massive experiment in monetary easing, effectively drove down interest rates.
Quantitative Easing also pumped lots of money into global economies through banks, which could access the money easily. By rights, Quantitative Easing should have been seen as a negative for companies. After all, it is never a good sign when drastic measures have to be taken by central banks to try to right a wrong in the financial system.
But Quantitative Easing and low interest rates provided lots of liquidity for the financial markets. It was deemed to be a cheap source of money, which excited both investors and traders. Banks that include DBS Group (SGX: D05), Oversea-Chinese Banking Corporation (SGX: O39) and United Overseas Bank (SGX: U11) would have been some of those that benefitted.
It meant lots of almost-free money to play around with. Consequently, continued bad economic news meant that even more money had to be printed. Effectively, it provided an endless source of money for investors to allocate, which in some cases was allotted almost indiscriminately. Bad news turned out to be good for just about every listed company.
Almost everything appeared to be worth investing in, even if the returns were not that great. The hunt for yield – any kind of yield would have done – drove up share prices to the point where dividend yields dissolved and earnings yields evaporated. But still, the free money kept on pouring in.
Then everything changed almost overnight. America decided that enough was enough, and it was no longer prepared to magic money from thin air, anymore.
Investors threw a tantrum, which caused share prices to thrash around as markets adjusted to a new normal. But today, some semblance of normality appears to be returning. Good economic news is now seen for what it should really be – good economic news. Some are still not convinced, though.
Some traders are still taking time to adjust, which is not surprising given that low interest rates have prevailed for around seven years. Some were still in short pants the last time that America increased interest rates. Additionally, the period of adjustment to a new normal could be quite protracted.
However, investors should not be overly concerned. Warren Buffet once said: “The future is never clear. You pay a very high price in the stock market for a cheery consensus. Uncertainty is the friend of the buyer of long-term values.”
The Sage of Omaha also said: “If Fed Chairman Alan Greenspan were to whisper to me what his monetary policy was going to be over the next two years, it wouldn’t change one thing I do.”
It should not change one thing that we do, either. Investing should never be about trying to second-guess the next steps that central banks might take. Nor should it be about trying to gauge market sentiment.
Instead, it should be about making a rational decision based on forecasting the yield of an asset over the life of the asset. It should also be about picking good stocks at good times and staying with them as long as they remain good companies.
Consequently, volatile markets, contrary to popular beliefs, could help us to buy some of those good stocks at even better prices. But to do so successfully, it is important to know with some degree of certainty the value of the assets we want to buy.
Knowing as much about the companies we invest in is paramount to investing successfully for the long term. Neither Quantitative Easing nor market volatility should affect the way that we think about investing.
Bear in mind, also, that when volatility drives up share prices, then that is perceived to be a good thing. But if volatility drives down share prices, then that is deemed to be bad. We can’t have it both ways.
What volatility does provide, though, is an opportunity to buy more of the assets that we like at attractive prices. If you can think of volatility in those terms, then you are thinking like a proper investor, rather than just another speculator.
A version of this article first appeared in The Independent on Sunday.
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