Extreme swings provide opportunities for the patient investor

Guy Stephens is technical investment director at Rowan Dartington
Guy Stephens is technical investment director at Rowan Dartington
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There is a phenomenon with stock markets known as "buying the rumour and selling the story".

This is also known as the difference between travelling and arriving. More commonly, it relates to good news expectation or some exciting development that gets everyone’s pulse racing.

The technology bubble is the best known recent case of this where the infinite possibilities of the internet were going to transform our lives and make billionaires of many.

This certainly wasn’t wrong, but it took ten years longer than everyone envisaged and no one had heard of Facebook, Amazon, Netflix or Google at that time. However, the "rumour" or "travelling" phase was the period from 1995 to 2000 when markets went ballistic and anything vaguely related to dotcom went stratospheric.

When the millennium finally arrived, the bubble burst shortly afterwards and much of the profit that had been made in the travelling phase disappeared when the reality arrived. Investors suddenly realised that everyone had been caught up in the hype and in reality, most of the forecasts for earnings were profitless. Those that bought the rumour and speculation but sold the story on arrival

were very wise, banked their profit and saw it for what it was – a bubble.

This phenomenon is a feature of human nature and the inherent greed and fear of the investor; anxious to make as much money as possible and not miss out when others are profiting, but also anxious not to lose money, especially when news headlines are reporting the sell-off as many start to panic.

It also goes a long way to explaining why markets often appear blind to the reality of when a positive development arrives – this is because all the good news is already priced in. Many an investor gets to the party late, not realising that the markets have been there for weeks – any upside is limited and a hangover is about to set in.

However, the opposite can also apply. When markets appear to be anticipating a doomsday scenario and sentiment feels extremely bearish, there is a point of maximum negativity where some investors capitulate and manage to sell at the bottom of the market cycle.

An example of this is Christmas Eve just gone, when a multitude of negative stories appeared to combine into an environment of

extreme weakness, not helped by thin holiday markets nor an overwhelming sense of desperation fed by the political turmoil.

Since that point, markets have rallied with the MSCI World Index rising by 12 per cent to the time of writing (Source: FE Analytics – 1 March 2019).

The FTSE-100 Index which also managed to hit a low on Christmas Eve, dragged down by the US market, has also rallied by 7.3 per cent despite all the Brexit noise (Source: FE Analytics – 1 March 2019).

If anything, since the market lows, the intensity surrounding Trump and his tariff negotiations with China and the approaching Brexit cliff-hanger has become much worse, but the markets have been rising.

This is travelling and arriving in reverse. The travelling period is the gradual realisation that the bad news that caused the previous low is fully priced in and all it takes is any glimpse of a ray of light for the gloom to lift.

Human nature defines the greed and fear characteristics of the markets. Over-expectation of the upsides and downsides leads to opportunity for the active and brave investor.

It is often said that time in the market is more important than timing the market. However, at times, extreme swings provide opportunity to boost the long-term returns that reward the patient investor.