The Seven Rules for Investors

Share markets have fallen sharply in recent times as uncertainty around US President Trump’s tariff policies have led to renewed concerns about the risk of recession at a time when share market valuations were stretched.    

It is impossible to say markets have bottomed out and we continue to see a high chance of a substantial correction, although financial year returns should still be okay.     

It is for investors to bear in mind are that:   

1. Share pullbacks are healthy and normal.   

2. In the absence of a recession a deep and long bear market should be avoided.   

3. Selling shares after a fall crystalizes the loss   

4. Timing markets is hard.   

5. Share pullbacks provide opportunities for investors to buy them more cheaply.   

6. Shares still offer an attractive income flow.   

7. Avoid getting thrown off a long-term investment strategy it’s best to turn down the noise.     

   
   

Introduction  

Much of the time markets are relatively calm and do not generate much attention. But now and then they tumble and generate headlines like “billions wiped off share market” and “biggest share plunge since…” Sometimes it ends quickly and the market heads back up again and it is quickly forgotten about.   

Every once in a while, markets keep falling. Sometimes the falls are foreseeable (usually after a run of strong gains), but rarely are they forecastable (which requires a call as to timing and magnitude) despite many claiming otherwise. In my long career as a financial adviser, I have seen many market tumbles, and they are nothing new.    

Now it’s happening again with share markets falling from record highs just a few weeks ago. From their all-time highs to their lows in February US shares have fallen 9%, global shares have fallen 8% and Australian shares have fallen nearly 9%. Always the drivers are slightly different.    

The plunge

The key drivers of the fall in shares are a combination:    

• Stretched valuations after a relatively calm year last year with strong returns.   

• While investor sentiment was not seeing the euphoria often evident at major share market tops, there was a bit of speculative froth evident in the huge gains in the Magnificent Seven stocks (Apple, Microsoft, Amazon, Alphabet, Meta, Nvidia and Tesla). These had accounted for nearly two thirds of US share market gains in 2023 and over 50% in 2024 taking them to roughly 35% of the S&P 500’s market capitalization. Their huge gains left them vulnerable to a pull back.  

• Sticky US inflation saw expectations for Fed rate cuts this year wound back.  

• The ignition point for the market fall has come from the frenetic and often contradictory policy announcements from the White House around tariffs, public sector cutbacks and US relations with allies. This has contributed to a run of weaker US economic data, fears of recession and desire by investors for a higher risk premium from shares.   

• As always, the most speculative “assets” are getting hit the hardest and this includes tech stocks (with the Magnificent Seven down 20% and Nasdaq down 14%) and Bitcoin (which has fallen 23%).     

Investors take heed  

Sharp market falls are stressful for investors as no one likes to see their investments (including their super) fall in value. But there are some key things investors should keep in mind:  

1. Market corrections are a normal part of investing in shares. But while the falls can be painful, they are healthy as they help limit excessive risk taking. Volatility is the price we pay for the higher longer-term returns from shares compared to more defensive assets like cash and government bonds.   

2. The main driver of the depth of a correction is whether we see a recession or not – notably in the US, as the US share market leads all major global markets. Trump’s policies and the noise around them has increased the risk of a US/global recession. Recession is now a more significant risk so it’s too early to say shares have bottomed out. Of course, short-term forecasting is fraught with difficulty and should not be the basis for a long-term investment strategy, so it’s better to stick to long term investment principles.  

3. Selling shares or switching to a more conservative superannuation investment strategy whenever shares fall sharply just turns a paper loss into a real loss with no hope of recovery. The best way to guard against deciding to sell on the basis of emotion after falls in markets is to adopt an appropriate a long-term strategy and stick to it.  

4. When shares fall, they’re cheaper and offer higher long-term return prospects. So, the key is to look for opportunities’ pullbacks provide. Maybe it is a time to invest? 

5. While share prices have fallen dividends have not. While the rebound in interest rates since 2022 reduced the yield advantage shares had over cash it’s likely now starting to wide again with the RBA starting to cut interest rates and likely to do more. More than 50% of companies raised their dividends compared to a year ago in the just completed December half earnings reporting season so the income flow from a well-diversified portfolio is likely to remain attractive.  

6. Shares often bottom at the point of maximum bearishness, just when you and everyone else feel most negative towards them. So, the trick is to buck the crowd. “Be fearful when others are greedy. Be greedy when others are fearful,” as Warren Buffett has said.  

7. Turn down the noise. At times of uncertainty like now, the flow of negative news reaches fever pitch. Talk of billions wiped off the share market and of “crashes” help sell copy and generate clicks. The share market has a total value of $2.77 trillion (about $8,500 per person in the US) so a 1% fall will wipe off $28bn. But less newsy are the billions that market rebounds and the rising long-term trend in share prices add to the share market.