Like frequent flyers, frequent investors can tend to ignore the safety briefing each time they take off. Now might be the time to pay a little more attention. As with an airline flight, that doesn’t necessarily mean there is an imminent danger; it just acts to raise awareness.
The local share market, like the US market, has been jumpy. Unlike Wall Street, our market is below its peak levels and has been easing recently, largely because the Australian dollar has been weakening and exacerbating fears about China and iron ore prices. But this might not necessarily be the time to switch from Australia to Wall Street because, if there is turbulence ahead, it is more likely to involve international geopolitical events.
Swan lake
A lot of day-to-day movements in the share market simple follow daily market commentaries on the minutia of regular data, which sends traders rushing from one side of the boat to the other. The big worry, however, may be the appearance of a “Black Swan”, which catches everyone completely off guard. Nassim Nicholas Taleb, who coined the term in his 2001 book, defines a Black Swan event as something outside regular expectations (what the experts call an outlier), that has an extreme impact (like the Lehman Brothers collapse) but, once it happens, becomes explainable and predictable (as all the experts who missed it explain why).
New York University’s Nouriel Roubini, who is credited with forecasting the 2008 collapses, last week noted that investors seemed complacent in the face of several worrying geopolitical factors and wondered what might disturb the markets. He carefully avoided the phrase “Black Swan” but suggested “markets tend to disregard the risks of events whose probability is hard to assess, but that have a major impact on confidence when they do occur.”
He argued that, while global markets might seem “rationally complacent”, financial contagion (like the GFC) couldn’t be ruled out because markets were, as always, poor at pricing low probability, high impact, tail risks. In other words, an outlier event or Black Swan.
Now all this doesn’t mean a Black Swan event is looming – they aren’t obvious until they occur – but it does remind investors to keep their eyes on geopolitical events as well as corporate earnings and economic data. If the worst does happen, they want to be able to avoid complaining “I didn’t see that coming.” For investors saving for their retirement, it’s not so much about forecasting a big dip as making sure your portfolio isn’t devastated.
Risk protection
This means investors should be asking “what if”? How vulnerable am I to a retreat in the stock market or in property? Can I still maintain the portfolio’s income, especially if it is paying out a pension?
It means investors should re-check their main investment compass – their asset allocation strategy – before piling into more shares or hybrids or property or cash. These days, this process should include a check on broad geographical spread. At the individual stock level, it means looking to see if any large individual holdings seem vulnerable. (Remember, you never go broke taking a profit, especially if it’s not taxable.)
If the portfolio still doesn’t look over-strained, there’s still the option of giving it an upgrade by weeding out the poor performers. This provides a chance to refresh the portfolio with stronger stocks or add to existing holdings at better prices – or simply add temporarily to cash holdings.
If investors have followed this routine, they should be well equipped and, more importantly, mentally prepared to ride out any short or long term disturbances. Most damage is done when investors panic and over-react. Sometimes it’s best to avoid the usual reaction of “don’t just sit there, do something”, and instead, as someone who has done a proper portfolio safety check, “don’t do anything, just sit there.”
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.
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Also in the Switzer Super Report:
- Peter Switzer: Now is not the time to lose faith
- Paul Rickard: SSR portfolio update: ‘dollar’ stocks make ground
- James Dunn: Four regional gems for your portfolio
- Rudi Filapek-Vandyck: Buy, Sell, Hold – what the brokers say
- Penny Pryor: Shortlisted – Oil Search and Boral
- Staff Reporter: Property buyers have eye on RBA
