By Rosie Murray-West
While share prices plunge and bears – or pessimists – rule the stock market, analysts are seeking comfort from their history books. They scrutinise charts of previous slumps, hoping for clues on how to survive stock market shocks and beat the bears.
Bear - The bear market has a way to go
Experts believe that lessons from history can stop us repeating the mistakes we have already made, and give us some tips on how to do better in future. Statistics show that no stock market downturn lasts forever. They also show that, even when downturns are swift and terrible, the way up can also come quickly.Current stock market shocks have been likened to everything from the 1970s oil crisis to the Great Depression.
"This downturn is new," says stock market historian David Schwartz. "But it is important to realise that every downturn is new. They are never exactly the same."
However, he claims that there are lessons to be learnt from studying what happens in the past. Schwartz says that he is confident that things are looking up, and that he expects to be buying shares in the next fortnight. "I have been sitting on the sidelines," he says.
Here are 10 tips from history to help investors survive, and maybe even profit from, current volatility;
1. This is not the end of the world.
It might seem like it, but the banking crisis is neither the end of the world, nor of capitalism, as we know it.
The current events have been compared to the 1980s crash, the 1970s oil shock, and, most scarily, the Great Depression.
However, even during the Great Depression, there were only two years during which equities – defined as shares broadly reflecting the composition of the London Stock Exchange – produced a negative return.
There has only been one time during the last century when putting your money in the bank would have beaten equities over an 18 year period. That was when investors bought shares just before the First World War, and then sold them during the Depression. The longer the period of investment, the more likely it is that shares will provide a better return than cash.
The lesson we can take from this is that now is not the time to panic if you already hold shares. Cutting your losses now will only crystallise them from paper losses to very real ones.
2. The stock market is forward thinking
The events of this week have made us more wary about prolonged global recession – which may depress the stock market for some time to come. But it is when the economy is in recession that the stock market will rise.
"People should remember that every rally starts when the economy is in recession, not when everything is a bed of roses," says Nigel Parsons, investment manager of Bestinvest. "Stock market rallies do not happen when everything is well in the world."
During the recession of the late 1980s and early 1990s, the UK stock market hit its low-point in the autumn of 1989 and started climbing – two years before the UK gross domestic product hit bottom. Economic recovery only started in earnest in 1993.
"Investors need to remember that the market may turn before there is much to cheer about in the economy as a whole," says Tony Stenning of BlackRock.
Similarly, in the Great Depression, 1932 and 1933 were times of high unemployment and economic difficulty. The stock market, however, produced a positive 34 per cent return in 1932 and a 25 per cent return in 1933 – although this does not take inflation into account. Therefore, if you want to capitalise on the stock market's return to strength, or even mitigate the falls you have already been exposed to, do not wait until the economy has recovered. You will have missed your chance.
3. A partial recovery in the stock market comes quickly – but full recovery will take a long time.
Analysing previous downturns shows that the market tends to recover half of the value that it has lost relatively quickly, whereas the rest will take far longer.
During the Great Depression, the stock market lost 85 per cent of its value. It gained half of that value back within four years and four months, but took over 21 years to regain its previous highs.
Shorter bear markets also follow this pattern. During the 1970s oil crisis, the market lost 44 per cent of its value. It recovered 50 per cent of this in five months, but took a further 5 years and four months to recover the rest.
These trends tend to form pronounced V shapes in stock market charts which are then followed by a slow climb upward. They mean that investors hoping to cash in on a return to stock market highs need to be in the market at the right time, otherwise they will miss the fastest part of the stock market bounce.
4. It's time in the market, not timing that market that counts
It's an old adage, but you hear it so often because it's true. If you want to profit from the bottom of the market, be prepared to invest before the market hits rock bottom, and be prepared to stay in.
Stenning points out that investing regularly pays dividends. "Anyone who had a regular monthly savings plan during the equity downturns of the early 1990s or 2000s would have been pleased with the outturn a few years later," he says.
No matter how many charts you analyse, you are never going to manage to buy at the very bottom of the market and sell at the top. By investing regularly you should be able to smooth out the downturns in the market over the
5. There are indicators that could help you predict when the market will turn
Stock market history buffs point to a variety of indicators when trying to work out how far the market will fall. One is the crossover between dividends and gilt yields. At present £100 invested in company shares would give you more in dividend payments than benchmark Government debt.
Some investors say this only happens when shares fall too fast, and signals a good time to buy. Another is the VIX index – also known chirpily as the Fear Index. This is a measure of volatility, and it showed its biggest leap ever last week. Experts say that peaks in the VIX are often accompanied by a short-term stock market rally. However, those of us looking for long-term stability will be looking for a lower VIX value, as an indication of greater stability.
At the time of going to press the VIX has fallen slightly from peaks of 69.95 to 54.9. However, this is still very high compared to numbers in the low twenties in August and September, suggesting that there is more volatility to come.
6. The first rally is often not an indicator of immediate recovery
Monday's stock market rally was extraordinarily strong but was followed by setbacks later in the week. According to Fidelity, in percentage terms Monday's rally was the second-best biggest rise for the FTSE 100 since 1984, and the fourth-best day on the FTSE All-Share Index since 1969.
However, the first big stock market rallies are often isolated incidents, and not the beginning of a true recovery. The charts show large rises in 1987 directly after Black Monday. But a true recovery was still some time away.
Simon Ward, chief economist at New Star, says the current market somewhat resembles the bear markets between the first and second world wars. A chart extrapolating from this suggests a near-term rally, followed by an extended plateau. If this extrapolation was correct then the market would then lurch down to a bottom around the levels reached in 2003.
A sustainable recovery would occur only in 2011. "It would be unwise to place too much weight on mechanical historical comparisons but the suggestion of an imminent base followed by an extended sideways movement is plausible," he says.
"Valuations are now low – the price to book ratio of UK non-financial stocks is at levels last reached in 1992 – but buyers are likely to be slow to return after the confidence-shattering events of recent months."
7. Corporate debt will recover first
When investing in a bear market, some sectors are likely to prove more resilient in a protracted downturn. Others are likely to recover quickly when the market turns. Parsons claims that corporate debt is one of the first investments to recover. "At the moment you can get yields of between seven and eight per cent on secure corporate debt," he says. "That is way more than on government stock."
For most small investors, the easiest way to invest in corporate debt is through a bond fund. Some of these, including Axa Sterling's Corporate Bond Fund, F&C's Strategic Bond and Extra Income funds and Old Mutual Dynamic Bond funds have been hit by the collapse of Lehman, whose bonds became worthless.
Both Justin Urquhart Stewart at Seven Investment Management and Mark Dampier at Hargreaves Lansdown are optimistic on investment grade corporate debt.
Dampier says there is an awful lot of bad news already priced into corporate bonds and that they may be looking better value, though he adds that we are not out of the woods yet.
8. Some shares weather the storm better than others
History suggests that the first stocks to come out of a downturn are usually found in five sectors: industrials, consumer durables, materials, information and financials. These are the same sectors that tend to fall furthest in a downturn.
"Property is the last sector to come out of a downturn," says Parsons.
This position is further confused by the role of Government in banking at present, so the trick is to look for companies with strong balance sheets and which pay good cash dividends.
Jeremy Batstone-Carr, analyst at Charles Stanley, suggested that with a recession inevitable it is important to consider companies whose earnings are uncorrelated to economic cycles. We have been keen on pharmaceuticals stocks and healthcare companies," he says. "We like Glaxo – it has reliable growth prospects, good cash flow and a strong balance sheet."
He also suggests mining stocks for those with a long-term view and more appetite for volatility. Neil Woodford, fund manager at Invesco Perpetual, also likes classic defensive stocks such as tobacco, pharmaceuticals and some telecoms, as well as the oil sector. Other stocks to look at include companies that will do well out of a consumer downturn.
JD Wetherspoon, the pub company, has done well on the stock market already this year for one reason: it offers cheap drinks. Exactly what consumers are looking for at the moment.
9.The gold price is a measure of consumer fear
During a financial crisis, the price of gold rises, because it is seen as the last safe haven. During the last few weeks, some investors have even been trying to buy gold on eBay because there has not been enough to go round. Traditionally, it has been one of the safest investments during financial turmoil. In 1973 it cost $60 an ounce, but hit $650 in 1981. However, it has been quite volatile during the current crisis.
Gold did very well during the financial crises of the 1970s, but in the current crisis the price has moved around a fair bit. About a year ago, the gold price was $667 (£370) an ounce, and it rose to a peak of more than $1,000 on March 17 – coinciding with the collapse of Bear Stearns investment bank.
However, since then the price has fallen and was trading around $848 this week. For long-term investors, there are various ways of holding gold, either in a fund or in the metal itself. A cheap way of tracking the gold price is through an exchange traded fund (ETF). In the five years they have been available, they have provided a cost-effective and easy way for investors to gain exposure to gold without physically owning it.
ETFs are not technically funds, because they follow a single security that is traded on the London Stock Exchange. They track the gold price and can be traded daily – all you pay is the dealing charge of around 0.4 per cent.
Another option is a gold account. Gold bullion banks offer two types of gold account – allocated and unallocated. An allocated account, such as that offered by BullionVault.com, is like keeping gold in a safety deposit box and is the most secure way to invest in physical gold.
The gold is stored in a vault owned and managed by a recognised bullion dealer or depository. With an unallocated account, investors do not have specific bars allotted to them. One advantage of unallocated accounts has been the absence of any storage or insurance charges, because the bank reserves the right to lease out the gold.
A gold fund is a pool of shares of gold-mining companies. In theory, when the gold price rises, gold miners should do well and share prices should climb. There are a few funds to pick from, with the most popular being BlackRock's £1.7bn Gold & General fund, which invests in the shares of gold-mining companies as well as other commodity businesses.
However, for those who believe the stock market will recover quickly, it is worth noting that gold does not provide any income, and they may do better in the long-term with equity investments.
10. Only a few fund managers will beat the bear market
Citywire has identified fund managers who have a proven record of beating bear markets in the past. They may be worth a look.
Graham Birch from BlackRock Gold & General, dubbed Goldfinger by his peers, is one such manager. Others include Neil Woodford at Invesco Perpetual High Income, Richard Woolnough at M&G Strategic Corporate Bond fund, Bill Mott at Psigma, and Edward Bonham Carter at Jupiter.