The markets say sell, but should investors listen?

These are incredibly challenging markets. It seems as if investors and traders have made up their minds that asset prices are going lower. Every time a piece of news emerges, no matter how bad or good, the selling begins.

How should investors react to this environment? In my opinion there is no clear answer.

In times like these, many market commentators and analysts will roll out the common refrain that holding on is the best way to manage volatility as asset prices always recover in the long term.

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While this is correct, I think the advice is often misleading. It’s true there is a high probability markets will be higher in ten years than they are today, but this refers to the stock market in general.

The only way to replicate this performance would be to own an index tracker fund. It’s not necessarily true of individual investments or even active investment funds.

Picking winners is always going to be a challenge

Multiple studies have shown that in the long-term the vast majority of market returns come from just a handful of stocks. These companies perform so well they more than make up for the drag of underperformers.

The chances of finding these companies is tiny. By one estimate, just just 4% of stocks in the S&P 500 account for more than 90% of its returns. Flip that figure on its head and you get a 96% chance of picking the wrong stock.

This is the reason why I think it’s a mistake to subscribe to the mentality that the best course of action in uncertain times is to do nothing.

Some companies will not emerge from the current economic storm in one piece.

Other companies will emerge stronger.

Investors need to have an honest discussion with themselves about whether or not the enterprises they own in their portfolio have what it takes to survive and thrive over the next year and beyond.

Indeed, in the UK we face a unique set of economic circumstances. As well as the energy crisis, the country is also dealing with the disruption of Brexit and political uncertainty.

Other countries have their own unique problems. The risk of blackouts in Europe over the winter is growing, and the chances of another debt crisis in Italy are also building.

Meanwhile, the US is struggling with runway inflation, ageing infrastructure, political roadblocks and a surging dollar, which is likely to hit corporate earnings.

Every market has its own strengths, weaknesses, opportunities and threats. Navigating all of these is going to be a challenge. There’s just no sugar coating that fact.

There’s no sense kidding yourself

This is why investors need to be honest and realistic about the holdings they own. I believe the companies with the best chances of being able to chart a course through this storm are the ones plugged into multi-decade macro themes, think healthcare, cloud computing, fintech, luxury goods and data.

The companies that are likely to struggle are those in sectors exposed to the economic cycle and disruption, such as industrials, brick-and-mortar retail and potentially even oil and gas (yes you read that right).

Oil and gas groups are awash with cash today, but they’re still exposed to a range of risks. These include windfall taxes, environmental levies and regulation. The current energy crisis could also accelerate the transition to green energy, which could lump them with tens of billions of pounds in stranded assets (I said this was a challenging time to be an investor).

Unfortunately, renewable generators are just as exposed to windfall taxes and additional regulation.

In these markets investors need to choose which risks they’re most comfortable with taking, and most importantly try and keep a balanced view on the world. The outlook for the global economy might seem awful right now, but as history shows, periods of economic stress are usually followed by growth and prosperity. Finding the companies that can make it through, and come out on the other side ready to take advantage of the opportunities on offer is vital.

There’s no sense hanging on to businesses that are really struggling and on the verge of collapse in the hopes they’ll be able to turn it around.

The world is changing and investors need to appreciate this fact. As the economist and investor John Maynard Keynes once said, “When the facts change, I change my mind - what do you do, sir?”