How to Invest in Highly Emotional Markets—and Earn Solid Returns

Garret/Galland Research |

Image via Flickr CC/Patrik Nygren

Shrieks of an imminent market collapse seem to surface almost weekly since the Financial Crisis. Swayed by the warnings, many conservative investors have liquidated their equity holdings to defend against the coming storm.

That a meltdown has failed to occur has not slowed the pace of predictions. There has been ample fearmongering since 2008, but it took on a life of its own last year.

It began in January 2016, when the Shanghai Stock Exchange dropped 24%. Then came “Project Fear” during Britain’s EU referendum in June. Then there was the summer’s Deutsche Bank scare, with its imminent collapse likely to take down the financial system. Most recently, we had to endure the constant cries of market crashes if Donald Trump was elected President.

Well, here we are, one year later in January 2017, and the UK and US economies look renewed by each country’s respective decisions... the IMF projected that China will account for around 40% of global growth in 2016... and Deutsche Bank shares just had their first positive quarter since Q1 2015.

If you bought into these tabloid tales and huddled on the sidelines with your investment dollars, you were doomed.

So, just how much did they leave on the table?

Defensive Blunder

The S&P 500, which declined 37% in 2008, has risen 60% since. The Dow Jones Industrial Average tagged along with a 55% gain. Investors would have enjoyed 7% annual returns by simply buying the waterfront.

The 30% jump in the US Dollar Index (DXY) since 2008 is another example of how dire calls for the dollar’s death missed the mark. Gold enjoyed a 26% increase, though it has not performed as well as many expected given the economic backdrop since the Financial Crisis.

Of course, no one could have predicted where markets would be today in the aftermath of the 2008 crash. However, based on the bureaucrats "whatever it takes" attitude, investors who stayed on investment lock-down ignored obvious opportunities.

My words come with a caveat. Many of the problems cited as proof of impending economic trouble are serious. High debt levels, weak global growth, and adverse demographics are real concerns. But the last eight years have shown that what is inevitable, is not necessarily imminent.

Instead of acting on extreme prophecies—i.e., certain doom or new market highs forever—investors must make their own informed decisions. This might seem obvious, but it’s not easy to do.

So, how can we give ourselves the best chance of earning investment returns in emotional markets?

The Value Thesis

Just like Benjamin Graham and his protégé Warren Buffet, we believe value-investing is the single best strategy. Owning under-valued, quality companies is as close as you are going to get to a sure-fire way of earning steady returns.

A study from Fidelity Investments—which tracked annual returns in the S&P 500 and other value and growth indices from 1990–2015—found that value consistently topped both general and growth.

While we believe the US economy will face some troubling trends over the next decade, the past eight years have shown that battening down the hatches was a mistake. To earn returns yet erring on the side of caution, we follow value-investing principles to guide our decisions.

In emotion-charged markets, owning value helps us avoid investing in high-flying sectors. It also lets us profit from bouts of investor irrationality, like we saw during last year’s crash in the energy sector.

In the July edition of our Compelling Investments Quantified, we recommended a Fortune 100 energy company with a price-to-earnings (PE) ratio of 6.59. Less than two years ago, the company’s PE ratio was 23. Yet, over the same period, its cash flow from operations climbed 26%. The company also pays a healthy 2.6% dividend.

After less than six months, our recommendation has a total return of 18%. We keep our finger on the economic pulse to detect changes, and our value-thesis guides us in times of emotion-infused markets.

Spotting the economic hurdles ahead does not mean you should exit the markets because of them. If you follow the principals of value-investing, even as the S&P and Dow Jones make new highs, you can still find plenty of opportunities while limiting your downside.

By Stephen McBride

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DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to:


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