Tag Archives: stock market

Navigating the Financial Seas: Gold and Stocks & The Recent Interest Rate Cut

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Despite the doom and gloom you might hear in the news, the world economy is showing some grit, holding its own. This has given central banks a bit of wiggle room to tweak interest rates, which is good news for stocks, though not so much for gold. However, with the political scene being a tad unpredictable, gold remains a hot ticket item.

All That Glitters: Gold Market Buzz

The gold market is shifting gears. Its focus is moving from Chinese investment and central bank purchases towards anticipation of interest rate drops in Western economies. Gold prices are soaring, especially after the European Central Bank’s second rate cut. Traders in the futures market are hopeful, expecting lower interest rates, and the physical market is buzzing with investors seeking safer options.

However, history teaches us that interest rate cuts alone don’t guarantee a gold price surge. In the past, gold usually climbed only if rate cuts led to a recession, averaging a 15.5% increase within a year. If there was no recession post-cuts, gold prices typically fell by around 7%.

Stock Market Standouts

US stock markets have generally done well when the Federal Reserve cuts rates, especially if there’s no subsequent economic slump. Since the 1980s, the S&P 500 has averaged a 14.2% return in the year after initial cuts, outperforming the average return of 10.4% over the same period. This suggests that lower interest rates, without a corresponding recession, usually make for a good stock market environment.

While the economic backdrop looks positive, market ups and downs may persist due to uncertainties around the upcoming U.S. election and concerns of economic slowdown. However, these fluctuations might be a blip in a larger upward trend. So, long-term investors might want to keep their eye on U.S. large-cap growth stocks, which are likely to lead the charge in this bull market.

Emerging Markets: A Mixed Bag

Historically, when the Fed cuts rates, emerging market (EM) stocks tend to do well, especially if there’s no recession. However, the U.S. elections could sway the outlook for EM assets. Any protectionist policies could hit them hard. So, given the current uncertainties, it might be wise to hold off on heavy EM investment until the economic picture becomes clearer.

Data shows that after the first rate cut, EM stocks often outdo developed markets, especially if a recession is avoided. While initial performance might not show big differences, a clearer picture usually emerges about a quarter later as investors assess the economic landscape.

While EM stocks might not be a priority right now, EM bonds could offer good returns in this period, presenting potential investment opportunities amid U.S. growth concerns. Things might become clearer once election risks reduce and signs of economic stability appear.

The Fed & its Rate Cut

The Federal Reserve cut interest rates by half a percentage point, the first reduction since early in the Covid pandemic, to prevent a slowdown in the labor market. Rates now range from 4.75% to 5%, impacting short-term borrowing costs for banks and consumer products like mortgages and loans. The committee plans further cuts, aiming for another full percentage point by the end of 2025 and a half point in 2026, despite a dissenting vote from Governor Michelle Bowman.

The cut seeks to restore price stability without increasing unemployment, which remains low at 4.2%. Although job gains have slowed and the unemployment rate is expected to rise to 4.4%, inflation outlook has improved to 2.3%. The decision caused market volatility, with the Dow Jones fluctuating significantly.

Concerns persist about the labor market, as hiring rates have dropped, suggesting potential future rate cuts may vary among committee members. The Fed’s last rate reduction was in March 2020, followed by three increases due to inflation. While other central banks are cutting rates, the Fed continues to reduce its bond holdings, lowering its balance sheet to $7.2 trillion, down $1.7 trillion from its peak.

Investor Takeaway

Overall, the current environment looks good for stocks, though the U.S. presidential election could cause some market nerves. For gold, while the environment usually doesn’t favor price increases, it still holds an important place as a diversifier in uncertain times. As central banks tweak their strategies, investors should feel comfortable with the current rate cuts, while remembering that every cycle is unique, especially in our current politically charged world.

Behavioural Finance

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Many people often think that money and emotions sit in two different parts of the brain; one is logical and requires objective thinking. The other is feeling, passion and response. However, the two often cross paths, sometimes without us even knowing it; we react emotionally to financial decisions. This is known as behavioural finance, and there are many different types of behavioural finance that one will experience throughout their life. Here, I want to explore each, and point out the pitfalls & traps we can fall into.

Herd Mentality

I feel that this may be one of the most common forms of behavioural finance that I see. It is very similar to ‘FOMO’ or following the crowd. Very frequently in life do people jump on the bandwagon of a particular fad or craze. These fads are often fleeting, and don’t stick around for too long (think of Pogs, Beanie Babies or The Atkins Diet), but during that short period of time everyone was talking about them and hyping them up. Similarly, think of NFTs, Dogecoin & Tulip Mania (the last one is real, look it up) in investing. Most of these fads don’t equal long-term gains, so it’s important not to get swept up in the excitement and think about long-term investment strategies.

Recency Bias

Recency bias tempts investors with fleeting gains and overshadows the broader market view. Many investors tend to be swayed by short-term views and information, and it’s incredibly dangerous for investors to extrapolate short-term recent trends far into the future. It can tempt an investor to abandon the critical principles of diversification, to focus on whatever has been trending over the past few years. This can be particularly risky if the investor already has fell privy to herd mentality. Take a look at the MSCI Emerging Market & the S&P 500 trends below; the dominance of emerging markets from 2000 to 2010 might have led some investors to believe that this upward trend could last forever. This, however, proved to be a misconceived notion, as we can see that from 2010 onwards, this has not been the case & the S&P has overshadowed the latter.

Loss Aversion

Imagine; you’ve spent a lot of time picking and choosing what stocks you want to invest in, but a bad market downturn massively affects your position, causing your investments to take a temporary downturn. Of course, this can lead you to feeling a lot of emotional pain and strife- you may no longer feel confident in your investments, and because of all the negativity this experience has caused, you contemplate withdrawing some, if not all of your investments. This can lead to hasty decisions, potentially derailing your investment strategy. Understanding the impact of loss aversion bias is crucial in navigating market uncertainties. It’s best to avoid this by frequently reviewing your investments and portfolio, ensuring your investment choices are aligned with your long-term financial goals. 

Familiarity Bias

Have you ever found yourself sticking to what you know in investing, just as you might choose a familiar path over an unknown trail? This is familiarity bias at work. It’s natural, but it might limit your investment horizons. Maybe some investors will only put their money in fixed deposits, because that is all they have ever known. Some may put their money in stocks in the same sector they work in, because they are familiar with that industry. It’s important to remember that not everything in life is going to be achieved following one path. When it comes to investments, diversification, investing for the long-term, and time in the market vs. timing the market, are key principles we must stick by.

Even the most rational minds can be swayed by emotions in decision-making. Behavioural finance is about the gap between what we should do – following our rational intentions – and what we actually do – which is often something quite different. This gap can be large and incredibly costly. No matter how rational we think we are, everyone is prone to letting emotions guide their decision-making. The cost of one behavioural mistake – such as moving our portfolio to cash at the trough of a bear market – can outweigh any other investment decision we make. Advice that helps us avoid such situations can be transformative.

How Did One Of History’s Smartest Men Get Scammed?!

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Even though we’ve all heard the phrase, ‘if it’s too good to be true, it probably is’, there are many that will choose to ignore red flags in the hope that this is not the case. This is true even in investment- if fact, I have written many articles on risk tolerance vs reward, and investment scams (I’ll link below). But it seems that investment scams are not a new thing, and even the smartest person could still fall for them! Did you know that even Sir Isaac Newton, the man who discovered gravity, fell for an investment scam!

Why Financial Advice is Better than DIY
Read up on how a professional can help you avoid investment scams!
Is Volatility A Good Thing?
Why fluctuations are normal in the market, and how not one investment can perpetually go up, without any downs.
How To Spot An Investment Scam
How you can do your own due diligence in spotting an investment scam!
The Pros and Cons of Crypto!
An example of a bubble many investors bought into…

In the early 1700’s, Sir Isaac Newton lost £20,000 in the South Sea Bubble- this amount would now be worth approximately £4,000,000 today! The ironic thing is that he had actually sold his shares in 1713 at a profit, but then was lured back in and lost it all when it bankrupted Georgian London in 1720.

The South Sea Bubble was a pyramid-scheme backed by the government, at the dawn of fiat currency. The Bank of Scotland had issued the first ever paper bank notes back in 1695, which Newton was a great advocate for. He had previously ran the Royal Mint, and he felt that the Mint could never keep up with the demand for producing coins to keep up with the growing economy.

Naturally, many during this period were suspicious of paper money, because it could be easily forged and had no intrinsic value, and Newton fell privy to many con artists and forged notes, in which he made it one of his missions to seek justice for.

But what was the South Sea Bubble and how did Sir Isaac Newton, one of the world’s most intelligent thinkers, fall for it? At the start of the 18th Century, the British Government’s debt was huge. To ease this burden, the government created the South Sea Company, by requiring investors to exchange their government debt holdings for South Sea stock. Much like ‘pump and dump schemes’ that we know of today, the company’s directors grossly inflated stories and hyped up the company so much that new investors saw impressive returns, such as Newton, whose first investment grew by 100%. It was at this point that he sold his stock, happy with his profit.

However, as the stock continued to rise, Newton became envious of those who were still invested. He became so envious, in fact, that he bought into the stock again, and put a larger amount of his wealth towards it. The South Sea Company achieved very little in terms of growth and in September 1720, the bubble finally burst, rendering many of its investors bankrupt.

What Can We Learn From This?

Although Sir Isaac Newton was more intelligent than most, he still made many common human errors. The first is FOMO (fear of missing out), which isn’t just applicable for not going out to the party; he saw everyone else enjoying the continued profits and felt that he shouldn’t have cashed out early. Herd mentality was another human error- quite often people will want to follow the crowd, and invest in an asset class because ‘everyone is talking about it’ or ‘everyone else is doing it’ (NFTs & Crypto ring a bell anyone?). He quite obviously ignored the red flags and practised ‘selective hearing’- remember this man co-created calculus; he should have known that the numbers weren’t adding up and this was a bubble soon to burst, but he ignored the warning signs.

The most fatal flaw arguably, was greed. People become excited at the thought of making money quickly, and unfortunately this is a driving factor in people making poor investment decisions. He did not take the emotion out of investing, and succumbed to greed. If you can put your emotions aside, you can actually become a better investor than Sir Isaac Newton.

How To Take Emotion Out Of Investing
Why emotions can hinder investment planning.
How To Be A Successful Investor!
How can you not make the same mistakes as Newton!

How To Take Emotion Out Of Investing

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As you may already be aware, many of my articles are about investments; how much you should invest and what you should invest in. I’ve even brushed on a little bit how you can be a disciplined investor. Today I want to delve further into this topic…how to take emotion out of investing. This may seem like a simple thing to do but, when money is involved, feelings are bound to get hurt.

A CFA Institute study showed that over a 30-year period, the average US equity investor achieved a return of 3.8% per year. But, surprisingly, the S&P 500 gave 11.1% returns. What’s the reason for the huge difference? Why did people not reap the full rewards? The answer is very simple…bad timing of the market.

Emotional investing is a bad strategy that I would not advise to anyone. Many people panic if the media hypes up a stock, or predicts that a market will crash. This is almost a self-fulfilling prophecy. If anyone remembers about Y2K, or has read up on the Dot-Com Bubble, you will know that the media told everyone that computers would crash (due to the computers thinking the year ‘00’ would mean ‘1990’) and that everyone’s bank accounts would be wiped when the servers had this tech error. Of course, this didn’t happen. But the media phrenzy caused stocks to plummet, and when there were so many web giants, we were only left with a few, like Google, Apple and Amazon. Playing into this fear caused thousands and thousands of people to lose their money on the stocks they had.

Fear is very often the driving force behind bad investing, and its co-pilot is greed. These two emotions can cause investors to buy at a high price (in hope it will go higher) and sell low (panicking that it won’t go back up). This clearly is not going to be fruitful or give you decent returns in the long run, so how can you avoid this?

There are two key ways to take the emotion out of investing and think rationally with your investing. The first is diversification. This is a word I have mentioned a lot in previous articles. Diversification is the investment strategy of buying an array of investment types; stocks, bonds, buying equities in different countries, different industries and just generally not putting all your eggs in one basket. There are only a handful of times in human history, when all markets have moved up or down in unison, so this method provides a buffer against volatility. Because one investment’s losses are offset by another’s gains, your portfolio will survive long term.

The next method to remove emotion from investing is dollar-cost averaging. I have also mentioned this several times before in previous articles. This idea is simple; invest the same amount of money in regular intervals. This strategy can be used during any market trend, up or down. The key is to not change or falter from the amount and the time intervals. Don’t tamper with it at all, and be disciplined to follow this method long term. This will remove all emotion out of your investments and you don’t have to worry about timing the market.

To conclude, we are humans, it is almost impossible not to factor emotion into our day to day lives. However, using these simple methods of dollar-cost averaging and diversification, you will stop these bad investing habits and succeed in the long run. To further remove emotion, I suggest doing passive investments, so that you are not the one looking over your funds.