As recent market turmoil has shown, investors should always expect the unexpected.
At the beginning of August 2024, all was fairly calm on the world’s financial markets. It seemed that investors could embark on their summer holidays confident that their nest eggs were secure. Indeed, they could even hope for some continued growth into the bargain.
And then the carnage began. Sparked mainly by an unexpectedly weak jobs report in the US that compounded recession worries – and coming just a few weeks after American markets had hit record highs – Wall Street suffered its worst day of trading in almost two years. Indices around the world also saw significant falls.
On this occasion, a full-scale crash failed to materialise, but the sudden reversal was a salutary reminder of the fragility of the world economic status quo. Threats often materialise out of the blue, as it did in this case. But there are other threats that lie in the realm of what former US Secretary of Defense Donald Rumsfeld once termed “known unknowns” – risks that we know exist but are impossible to accurately predict.
Elections, conflicts and irrational exuberance
Geopolitical events are notoriously difficult to forecast, and can have major and long-lasting effects on the global economy. In a year during which more than half of the world’s population is going to the polls, the IMF has frequently warned of the potential negative effects of major swings in economic policy associated with national election results. This is nowhere truer than in the US: if Donald Trump triumphs in November, he has signalled that he will instigate even more protectionist trade policies aimed at China than the Biden administration has already put in place.
The upshot of this would likely be inflationary pressure in the US and a heavy drag on the export-dependent Chinese economy. “What happens in China has implications for every economy,” says Zain Vawda, Market Analyst at leading online broker OANDA. “When Chinese growth slows, it has a knock-on effect across the world.”
The ramifications of military action around the globe also present further known unknowns. In his first speech as the new head of the British Army, given in July 2024, General Sir Roland Walker warned of a range of threats in an “increasingly volatile” world. There are currently more than 100 active armed conflicts taking place, with those in Gaza and Ukraine the two with the greatest potential significance in economic terms. If the former escalates into a full-blown regional conflict, the consequences could include rocketing oil prices and major supply chain issues through the Red Sea. In the latter case, Walker warned specifically about the threat to the UK and western countries of an “angered” Russia. Even the hint of an escalation in Ukraine could change the face of the markets for six months, according to Vawda. “Just one missile landing in the wrong place could be enough to trigger a sell-off,” he says
Downturn rumours
Prior to the events of early August 2024 there had already been increasing talk of a market downturn, in the face of the return of the kind of “irrational exuberance” of investors first identified in a 1996 speech by the then Chairman of the US Federal Reserve, Alan Greenspan. Specifically, tech stocks had seen huge growth in the 18 months to July 2024, fuelled by investor enthusiasm for companies that might benefit from advances in artificial intelligence. In the US, the share price of leading AI company Nvidia had increased by a staggering 745 per cent, with major gains by other leading AI players, including Meta Platforms, Amazon, Alphabet and Microsoft.
Overall, the S&P 500 index, where Big Tech dominates, had advanced by 45 per cent since the start of 2023, leading to comparisons with the dotcom bubble of the late 1990s, which burst spectacularly in early 2000. Could the same happen again? Big Tech stocks have already fallen from their highs and a sign of waning enthusiasm for them can be seen in the fact that Warren Buffett’s Berkshire Hathaway company has sold half of its Apple stock since the beginning of 2024. Vawda thinks a crash is unlikely, but doesn’t rule out a correction by as much as 20 per cent in the S&P over the next six months.
The importance of long-term thinking
How can retail investors mitigate the effects of future negative events? First of all, it is important to take a long view, Vawda believes, especially for newer investors, who grew up seeing huge profits being made in the cryptocurrency markets, often in the space of just one or two years. “The younger generation – my generation – often want instant success,” Vawda says. “Which is understandable but doesn't always have to be the right choice. It is important to pay attention to the market, ask oneself what our end goal is and adjust the approach accordingly.”
Investors looking for swift wins can fall into the trap of becoming obsessed with timing the market and looking for the perfect moment to buy or sell. Vawda says it could also be important to spend time within the market.
“In volatile times, remaining in the market for the long term can be a beneficial approach for some investors,” Vawda explains. “Observations suggest that patience, a comfortable investment plan, diversification and spreading risk might be effective strategies for investors. If you do decide to stay for the long haul, goal number one could be trying to make sure that your portfolio can last for at least 20 years. Still, the decision to ride out the volatility comes with its own risks.”
There are no hard and fast rules, because every investor is in a unique financial situation, says Vawda. However, he believes that, before making any kind of investment, an individual should ask four questions. Is the product suitable for me? How long is my investment horizon? What returns am I looking to generate? And what is the purpose of the investment? “But remember that investing always involves risk,” he adds. “It’s essential to make informed decisions based on your personal circumstances and financial goals.”
This content was paid for by OANDA and produced in partnership with the Financial Times Commercial department.
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