Your Behavior Has Unconsciously Caused You To BUY HIGH And SELL LOW
The relentless European debt crisis continues to lead the global equity markets to nowhere. Weak sentiment has dominated lately and we see panic selling setting in. Under such a volatile market condition, it is very important for investors to distinguish between the price and value of a given market. If we write the relationship between price and value over the short-to-medium term as a mathematics equation, it will be:
Price = Value + Sentiment
The price of a market tends to be elevated when sentiment is strong (e.g. during a bull market) but suppressed when sentiment is weak (e.g. during a bear market). This is because in general, investors’ willingness to buy tends to increase when sentiment is strong, despite the risk that the market is overvalued. Willingness to buy decreases and willingness to sell heightens (panic selling sets in) when sentiment is weak, although the market may probably be much undervalued.
As a result, investors who are typically sentiment driven have a very high risk of buying high and selling low.
3 Rules To Avoid Sentiment-Driven Investment Decisions
Rule 1: Prolong your investment horizon to a longer-term (e.g. 3 – 5 years or 5 -10 years).
Wishing to gain positive returns over a short investment horizon by frequent transactions is SPECULATION and not investment. If you know that the fundamentals of your investment justify a higher valuation over the long-term, you need not worry so much about the short-term price fluctuations. This is because over the long-term, value drives price.
Rule 2: Screen out headwinds and noises that cause short-term volatility but with no impairment to the long-term prospects.
The markets are full of good and bad news everyday that can influence investors’ sentiment. Identify the actual events that affect the long-term fundamentals and prospects of your investments.
Rule 3: Stay focused on the value of the underlying assets/markets that you wish to invest in.
Use valuations such as PE ratio to guide you on what to buy and what to avoid. Do not panic when markets crash. Focus on the value because when there is panic, the fundamentals may not be affected but prices could be suppressed. These could be buying opportunities for those who willing to see past the market crash and ride through the market volatility.
The price of an asset always fluctuates around its underlying value because of fear and greed. When market sentiment is weak, like the current situation and also during the global financial crisis in 2008, markets are likely to be undervalued after the major sell-off and hence, it pays off to keep an eye on valuations.
Based on our recent review of the current turmoil, we have upgraded the ratings of the following markets to 5 stars for their significant undervaluation after the recent sell-off. As a value investor, these are the markets that you should not overlook now.
The 5 Stars Markets:
- Emerging Markets
- Asia ex-Japan
- Greater China (China, Hong Kong, Taiwan)
What makes Emerging Markets exciting?
Looking Past The Current Turmoil - Upgrading 12 Markets; Downgrading Europe
Time To Review Your Investments?