💸 Are you fearful about investing in what seems to be a highly volatile market? Do you struggle to keep your cool while having your money invested? How should we, as investors, approach financial bubbles?

To help us get to grips with these questions, we spoke to Investment Director Lauren French, who specialises in managing complex client portfolios and developing investment strategies at Ruffer.

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what’s been up with the stock market?

• 2022 was an extraordinary year on so many fronts. We had real world big shocks, which exacerbated the market shocks. We saw everything from the biggest land war in Europe since 1945, the biggest global energy crisis that we’ve ever seen.

• On top of that, although it might feel for some like a distant memory, China was in the midst of its largest Covid crisis. We also saw economic forces like inflation at multi-decade highs and the fastest interest rate hiking cycle in decades.

• All of this combined made for a very toxic environment for nearly all conventional assets.

• Equities had the worst year since the financial crisis in 2008, and the US stock market was really in the eye of the storm. The pain was felt very acutely in very popular stocks last year. So in the period leading up to last year, these stocks performed very well. US technology stocks or those that are known as FAANG (an acronym for 5 prominent US tech companies: Facebook (Meta), Amazon, Apple, Netflix and Google (Alphabet)) — these stocks benefited for a long time from the low interest rate environment, and have thus been heavily impacted by rising interest rate pressure.

• It wasn't just equities. The bond market had its worst year for a very long time. This conventional method that investors talk about using offsets and diversity typically we look at bonds as more protective in nature and they can offset the equity market when it's having a hard time.

• But last year showed that this sort of conventional way of thinking about investing has broken down, with a typical balanced portfolio of 60% equities and 40% bonds falling nearly 20% across the whole of the year.

• There were basically no conventional assets which provided a positive return and safety.

financial bubbles?

• The image that a bubble denotes is much like when you blow bubbles with your children. And it's sort of appropriate way to start when you think to define this, it's free of any forces until they burst, and then there's a messy consequence afterwards.

• Financial bubbles are much the same. Robert Shiller is someone who does a lot of work in the space of looking at stock markets and is the behaviour of the market rational or not and logical. And he reverses that and calls a bubble an unsustainable increase in prices bought on by investors behaviour rather than by genuine fundamental information about value. That's the key here. It's the impact of our behaviour as investors on driving some irrational movements in prices.

• The problem with identifying if you are in a bubble is actually knowing that you are in one, and sometimes only knowing it once it's burst.

  • 1/ The first theme is that a bubble as it builds in a particular asset or stock attracts more and more new investors until ultimately it's something of almost like a national hobby or a pastime. Nobody wants to miss out on returns and everyone's talking about the assets. So you've seen that probably with recent examples, hot topics over dinner party chat like crypto. Suddenly you had families talking about trading crypto on their phone or when a taxi driver might give you a hot stock tip.

  • 2/ Bubbles sort of bring about this idea of a new normal or a new paradigm, something that's almost too good to be true which can be used to justify the higher valuations that you pay to justify paying higher prices. You need to understand why that is. Opening up these kind of extra possibilities of new substance which is often the case in early stages of a bubble, but then you see it's not quite enough to justify the hype of the valuations.

  • 3/ Thirdly, there are kind of feedback loops which emerge over time and become self-fulfilling, sucking more money in and intensifying the over-valuation point.

• There can be an attractive hunting ground after a bubble bursts. The key thing is it could reset a new market cycle or it could actually just mean that there's a whole new regime that investors have to get used to. You also can see the emergence of blame and people exposed as frauds as when there's high valuations.

staying sane during market stresses

• You should be looking for a conservative or cautiously managed approach even if you're doing that yourself. So that sort of foundation of “does this decision help me to sleep at night” is a good universal guidepost for wider financial decisions.

• Take a step back and think about longer term goals and keep focused on them and not being distracted by the noises is also important.

• As much as we like to think we might be rational, we're not when it comes to any life decisions, let alone the decisions we make with our own money. So if you think and reflect on your own past experiences with investing or currently if you're trying to do it now, really take a step back and think about the narrative that you've built around your approach to risk. It can be a rollercoaster of emotional investing.

• There are over a hundred financial biases that we can show in our financial decision making all the way through from anchoring.

• The whole idea of considering your biases and your relationship with risk and trying to remove some of that noise is a really powerful one, especially when you're thinking about your own journey with investing. The power of not losing money and having that kind of balanced approach in your investments, not concentrating too much in one area is a really good thing to do.

• Warren Buffet once said: “the most important quality for an investor is your temperament, not your intellect”. These sorts of crazy markets can cause one to act or not when you should. It’s a really important consideration to be aware of: these markets can swing quite quickly from an environment of extreme fear and that everything's doomsday scenario to one of greed.

• Think about the strategy you have to protect your overall capital. Consider whether you have the right balance of different assets in your overall portfolio, and start taking a step back to reflect on that, but also remind yourself of your wider objectives.

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You can follow and connect with Lauren at:

• LinkedIn

Resources:

• The Art of Bubble Spotting - Ruffer

• Robert J. Shiller on Bubbles, Reflexivity, and Narrative Economics

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