People with an addiction do not have control over what they are doing. Moreover, addictions do not only include physical things such as drugs or alcohol but may include abstract things like gambling or cheap money. Over the past four and a half years, global stock and bond markets splurged on near-zero interest rates and an unprecedented bond-buying programme otherwise known as quantitative easing (QE) by the world's major central banks.
Now we are beginning to see green shoots in the US economic outlook, with Federal Reserve chairman Ben Bernanke putting investors on notice for the first time that QE3 may taper off later this year, conditioned upon continued strengthening in the economy and lower unemployment.
I would have thought this to be fantastic news. The world's largest economy is finally on the mend and the patient getting ready to leave the ICU. Unfortunately, stock markets can be hard to figure out at times but are always worth listening to. June was a particularly tough month for the Stock Exchange of Thailand and the baht. Both suffered heavy declines as foreign investors bailed out from the region in droves at the prospect of a wind-down in QE.
In a way, you can't blame the investors, as one explicit goal of cheap money has been to push up asset prices, especially stocks, bonds, gold and real estate. As we know all too well much of those price increases are a function of speculative money flows _ i.e,. hot money rather than real productivity or earnings. Sooner or later something's got to give, and prices were bound to correct eventually. Now that the party is over, there is very little incentive for foreign investors to stay in this part of the world. Easy come, easy go.
My take on this whole sell-off is comparable to when an addict stops using drugs or alcohol _ it is like taking weight off a spring, and your brain rebounds by producing a surge of adrenaline that causes withdrawal symptoms. As with all addictions, the withdrawal is going to be volatile.
So in the short term, brace yourself for more volatility, but this too shall pass as normalcy returns. In a way this is extremely good news, because we can go back to the real world again where risk and return on different asset classes are no longer being distorted by central banks.
However, for a lot of investors, the extreme ups and downs in recent weeks have been hard to stomach and many people view cash as a riskless trade. Putting a significant portion of your portfolio into cash may seem like a good idea when times are uncertain and volatile. But there is a cost. Cash has produced negative returns after factoring in inflation and taxes. Past performance is no guarantee of future results, but I can guarantee this: holding cash is a sure way to lose purchasing power in the long run compared to stocks and bonds.
Equity market corrections occur fairly often _ it is rare to go a full year without one or more. Painful as it is to experience them, stock market corrections are part of investing in stocks. Historically, pullbacks of 5% or more happen on average 3.5 times a year, and pullbacks of 10% or more happen, on average, about once a year. As long as your portfolio is well diversified, you should remain invested for the long term and be very disciplined in using dollar-cost averaging.
Think of stock market corrections as you would with promotional sales at department stores. If I remember correctly, Central and The Emporium department stores hold midnight sales three or four times a year and megasales once a year. Each time, I usually find good bargains. It is the same with investing in stocks. You still buy the same companies but at a discount!
Teera Phutrakul, a certified financial planner, is chairman of the Thai Financial Planners Association.
About the author
Writer: Teera Phutrakul