A FOMO rally?

We have seen a pretty good bounce back from low levels in stock markets across the world following the ceasefire announcements bringing geopolitical events centerstage again. It highlights the fact that markets are focused on events and perceptions in the short term and they can be volatile depending on the direction of the same. When news are upbeat markets tend to rise and when risks rise across the world potentially affecting supply chains or spread supply shocks, markets generally fall. The operative word here is, potentially.

Reality vs Perception

Investors are focused on events since they have potential for economic fallout and in turn on corporate earnings. However, history tells us that such events even if “real” and in turn truly do cause earnings disruptions, over longer periods of time they tend to not damage long term returns trajectory in well managed companies. It is a clear and present danger to all business entities but generally it tends to get amplified in prices way beyond the actual damage. This is also called opportunity in other words

Why are such events not actionable?

Logic would tell us that an astute investor should wait for such events and deploy equity capital when such fear is high. But that is where the investing game gets interesting. The investing public can largely be divided into two broad categories; 1. Institutional and 2. Retail or individual investors. Each have their own limitations in exercising this logic at such times.

Institutional investors: These are large funds and agencies that deploy third party monies dictated by certain investment objectives. Flows into such funds are also a function of popularity of the theme, distribution capacity, track record and ease of entry. These rules are uniform for across the world in general. Experience dictates that these funds will necessarily be “long only” and will hold securities in its asset class over long periods of time regardless of timing incentives such as global geopolitical events. Performance track record is also shared over longer time periods as proof of concept. As a result, being fully invested does not allow for such events to be capitalized even if all parameters could point to a quick reversal and above average potential returns from such a point of time.

Retail or individual investors: This class of investors are the most vulnerable to behavioral pitfalls. As a result, they generally follow the crowd instead of leading them. If stock markets show sustainable rises over a period, most investors participate with a view of gaining from the momentum alone and not truly a measured and long-term approach to investing. As a result, the first frisson of anxiety sends them to offload their holdings creating transaction costs that eat into their meagre return (remember they enter late into a rally) and falling markets keep them away till markets start to rally again. Thus, they miss the entire run, opting for relative safety ensuing lower than average returns.

What would recent events point to in the near term?

Geopolitics as uncertain as ever

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• Volatility will always be a factor and recent events cannot estimate the future of markets in any way

• Markets have recovered across the world on the assumption of strong earnings growth and dramatic reduction of supply shocks, especially in energy markets

• Any risk to this assumption will ensure markets remain volatile and any under delivery of earnings will ensure they remain under a cloud for much longer

• The full impact of the current supply shock will turn up in inflation and subdued margins for companies affected and will only be clear over the next 2 quarters

• Confidence in earnings growth on a bottom-up basis will be the only indicator of resilience in stock prices while broader markets will be beholden to current news flow over this time

Asset Allocation will be key

A well-diversified basket of investments will hold the investors fear at bay however FOMO can never be captured. Just when investors swing to the current favorite and swivel away from a loser, following the crowd always leaves a bad taste in the mouth. A better approach would be goal based investing and sticking to a long-term plan. Here the behavior needed would be resoluteness in the face of longer-term data despite near term hiccups.

This long term approach ensures that one does not worry if the Strait is open or closed!

Happy investing!