Mark Dampier: Don't panic. Canny investors sit tight when the stock market falls

The Analyst

The recent stock market falls are nothing unusual; yet you might believe otherwise given the reaction of the press.

Many reporters would have been mere youngsters, or not even born, when the stock market fell spectacularly in 1987. On Monday 19 October that year, the UK stock market fell by over 10 per cent, while Wall Street dropped by around 25 per cent that same night, followed by a further 11 per cent the next day. Now, that was a serious plunge.

The latest falls have reached around 10 per cent, at the time of writing. While not welcome, there have been other severe declines over the past few years. Cast your mind back to February this year: the UK stock market fell 6 per cent amid concerns over the health of emerging markets. In May 2013, it fell 12 per cent when the US Federal Reserve announced it would taper its quantitative easing (QE) programme. In autumn 2012, US budgetary worries led to a 5 per cent drop, while fears over the US debt ceiling caused a 17 per cent fall in July 2011.

My point is that while these falls are of concern at the time, they are almost always forgotten fairly quickly as the market recovers. Investing is for the long term and so short-term corrections can present an opportunity. However, investors are constantly looking over their shoulders and commentators are forecasting the end of the world.

Most of the time, markets end up steering a middle course, but this does not create headlines.

From the commentators' point of view, there must always be a dedicated reason for a market fall. The current turmoil can be attributed to a mix of factors, including deflation fears in the eurozone and the outbreak of the ebola virus. In fact, there isn't always a reason, other than valuation. In the technology boom, the stock market fell in February 2000 purely because there was a realisation that excessive market gains had been built on sand.

Perhaps, this time too, there was a realisation the global economy still faces many problems. QE has helped inflate the prices of financial and real assets, and parts of the world, such as the eurozone, are still in trouble, But the world does not stop growing. In fact, the IMF recently nudged up its growth forecast for the US.

That said, much of the world still has to work its way through debt mountains. Politicians and central bankers have helped to avoid the worst consequences of the financial crisis by increasing debt in a bid to keep demand buoyant. It might have been better to let capitalism work through the system, destroying the weak companies and allowing a real recovery to get going. The short-term effects would have been far worse than we have seen, but a far stronger foundation would have been laid from which to move up.

On the valuation front, I would make the general statement that stock markets are neither cheap nor expensive, although both bulls and bears will point to different valuation measures to make their respective points.

The UK looks fair value compared with its historical average. I call this no man's land. In other words, the market could move significantly in either direction, but attempting to forecast the next movement is impossible.

What should the investor do? Unless your personal circumstances have changed, you should not consider selling an investment that you would not have sold a few weeks ago. I feel it is best to sit tight, and do nothing, unpleasant as it may feel. When it comes to investment, a general philosophy of inactivity is generally a good one. Of course, make sure you maintain a cash buffer at all times, even though interest rates are at an all-time low.

There is some good news. The recent fall in the oil price is the equivalent of a big tax cut for both consumers and industrial nations. Furthermore, while interest rates are unlikely to rise until after the general election, dividend yields on the UK stock market are above their 20-year average at over 3.5 per cent (net).

This is exactly why I always hold a significant portion of my portfolio in income-producing assets. When capital values fall, at least the income remains supported in many cases. I have recently taken advantage of market weakness to top up some of my holdings – all of which, I might add, offer a respectable yield.

Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds in this column, visit www.hl.co.uk