Crash course for investors

PUBLISHED : Monday, 15 August, 2011, 12:00am
UPDATED : Monday, 15 August, 2011, 12:00am


So here we are at one of those moments when fear overcomes greed in the world's financial markets. Investors are wondering what the hell they need to do.

Fortunately, we've been here before - a number of times, in fact. Each of these crises has followed similar patterns that provide good indicators for investors, despite the fact that most seem determined to learn nothing from history.

For those not merely interested in preserving their wealth, and who want an opportunity to benefit from the crisis, here are some of the lessons learned from the past.

At times of crisis, investors reliably behave perversely. They rush to buy what has become very expensive. Now, as in the past, that notably means gold. And they rush to sell at a loss, often a considerable one. The main victim of the current sell-off is equities, because they are easy to liquidate and because nervous investors can't shut out the noise about stock market doom.

The smart investor turns this pattern on its head and looks for bargains while remaining calm about his holdings. A smart investor does not worry about price falls if they remain confident about the underlying business of the companies whose shares they hold.

Once again, Warren Buffett, one of the world's shrewdest investors, is rubbing his hands with glee as asset prices fall. He swiftly moved in to buy the reinsurer Transatlantic Holdings as others were busy fleeing the insurance business.

Moreover, a crisis is a wonderful time to buy quality shares, those that are attached to companies with a strong earnings record. What typically happens in a stock market meltdown is that blue chips fall in price more rapidly than second-tier stocks. Partially, this is because they have more shares issued and they are therefore more liquid. It also reflects the numbing ignorance of investors who pay attention to price falls among big names while ignoring the carnage elsewhere.

Liquidity is a big issue during crises because markets that remain liquid are also likely to emerge with the greatest strength. So, perversely, it seems there is relief to be had from the fact that the Hang Seng Index has tumbled more than other Asian markets because this confirms the greater liquidity of the local market.

This provides opportunities for day traders and other opportunists who appreciate that the volatility is such that the biggest falls are accompanied by the biggest rises.

This is somehow overshadowed by the general mood of depression. But remember that after the stock market crash of 1929, which left markets depressed until after the second world war, the intervening period also saw the biggest market upswings in history.

Market crises produce rather startling anomalies. Right now, we can see the gold price rising to new records, while the price of that other heavily traded commodity, oil, keeps moving down.

Oil, unlike gold, is more than a repository for wealth. It has end users for all its output. Like gold, the supply of oil is finite and the subject of considerable trading by those who are purely interested in its investment value.

There is a fear of oil investment because of the belief that demand will fall as industrial production declines. Unless you believe demand will be permanently depressed, there is no reason to avoid oil investment. Yet this is what is happening in favour of investment in gold, which is seen as a 'safe haven'.

What do the doomsters have to say about the persistent demand for US government debt, the very issue that triggered this crisis? Here is a rare case of investors looking beyond the political noise and appreciating that even the craziest politicians cannot last forever and that underlying market realities will eventually reassert themselves.

The great unknown is timing. No one knows when the markets will hit bottom - so why try to pinpoint it? Surely it is enough to know that assets are available at bargain prices, rather than worry over the extent of the bargain. As for those with quality assets that have fallen in price, why scramble to sell when the price is so depressed?