xi's moments

To cope with black swan events-hang in there

By Charles Shi | China Daily | Updated: 2018-02-14 07:51

As the United States' economy has recovered in the wake of the 2008 global financial crisis, the US Federal Reserve has gradually raised interest rates. As a result, rates have risen from 0.25 percent in December 2008 to their current 1.5 percent. Although each increase had an initial negative impact on the stock market, every downturn has been accompanied by a subsequent rebound due to an influx of large buy orders.

Warnings of doom, therefore, have again and again turned out to be false alarms.

2017 witnessed a big surge in all the major markets with the bullish momentum continuing through January 2018. Marquee investment companies on Wall Street came out with a rosy outlook for the year ahead, with a consensus view that the global economy is currently in a "sweet spot" of low interest rates, low inflation and high growth. Nonetheless, a shock occurred unexpectedly on Feb 2, prompting the Dow Jones Industrial Average to tumble 666 points, the largest point drop in a day since June 2016.

The market sentiment continued to turn worse the following Monday, with the Dow plunging an additional 1,175 points, its worst daily point drop ever, triggering a subsequent massive sell-off in global markets. Market-wide panic selling caused the Hang Seng Index in Hong Kong to drop 1,600 points as some investors proclaimed that a black swan event had finally appeared.

To reduce losses, investors may be tempted to sell their holdings in hope of buying the shares back later at a lower price. In this case, they are among the 90 percent of market participants who exhibit overconfidence.

Richard Taylor, the 2017 Nobel Prize Winner in Economics, pointed out the prevalence of over-confidence among stock investors. Over-confident investors tend to believe they are capable of making a quick profit by timing a volatile market.

They mistake luck for ability. Sooner or later, they will have a rude awakening when their apparent clever market timing means they end up selling low in a bear market and buying high in a bull market. How often does that happen? Way too often!

However, if investors do not use margin in stocks and do not need to cash out their holdings in near future, then there is no need for them to panic. The market always bounces back following a big decline.

For example, during the 2008 global financial crisis, the stock values across major markets lost more than 40 percent. But they all bounced back in 2009 with the Hang Seng index regaining more than 50 percent and the A-share market in China surging more than 95 percent.

If you aim for long-term, more than five-year, returns, and the companies you are holding exhibit characteristics of low debt and high profitability, you do not have to join the herd of panic selling. Share in sound companies always rebound and the price will continue to march higher and higher.

I have been holding shares of a major US-based tech firm for more than five years and the shares of a leading Chinese tech firm for more than three years. During those periods, both stocks experienced numerous big declines, and they too have fallen considerably in recent days.

But I have not sold any of my shares in the two companies. Indeed, I have increased my holdings in them when prices temporarily fell.

Through a thorough analysis of the companies' quarterly and annual reports, and their respective industries, I have a deep knowledge of their core businesses, management teams and major investment initiatives and thus have confidence in their core competencies and ability to maintain high profitability.

Ultimately, investors cannot predict price movements. In the long-term, share price is determined by a company's financial performance.

The author is an associate professor at the National University of Singapore (NUS) Business School.

Copyright 1995 - 2018 . All rights reserved. The content (including but not limited to text, photo, multimedia information, etc) published in this site belongs to China Daily Information Co (CDIC). Without written authorization from CDIC, such content shall not be republished or used in any form. Note: Browsers with 1024*768 or higher resolution are suggested for this site.
License for publishing multimedia online 0108263

Registration Number: 130349