It began innocently with a fall in markets in China at first. It would have been mistaken for healthy clearing of froth from one of the worlds frothiest stock market. This drop started in Asia and was followed by a nasty fall in the American markets that Friday and gained considerable momentum after that.
This fall looked so worrying when Shanghai markets closed on Monday when the stocks decreased by 8.5%.It was the Shanghais composite worst single day in the last eight years and given the daily limits on how far individual stocks could fall, very nearly the biggest possible decline.
This day was declared Black Monday by the peoples daily that is the mouthpiece of the Communists party. There was nervousness all over which radiated outward from China, affecting Nikkei index in Japan and which slipped by 4.6%, European bourses fell by 4% to 5%.The Euro first 300 index had its worst day since 2009 while the German DAX lost all its gains made in 2015.
This pain was felt beyond stock markets as emerging market currencies such as the South African rand to the Malaysian ringgit were tumbling. The value of commodities was also sinking with oil hitting a six and a half year low. Bloomberg compiled a broad index of 22 commodities, and they were at their lowest since the year 1999.The only safe-haven assets were government bonds issued by countries like Germany and America had good days. Precious commodities like Gold went down. Investors who used Gold as collateral to buy shares and other assets have to flog it to meet margin calls.
So we ask ourselves, what caused the jitters in this markets and how much should investors worry? If we look at a case of China, the proximate cause of all this is a series of events that lead to the astonishing devaluation chain of the Chinese Yuan on August the 11th.Since then, more than $5 trillion has been wiped off on global stock prices. Chinas industrial activity seems to be slowing sharply since the Chinese government has failed to unveil bold new market interventions to prop up equity prices.
With the weakening outlook for Chinese growth and the slip in Chinas currency, pressure is being exerted on emerging economies and especially those whose growth model depends on the demand for industrial and other economies. The Fed has squeezed most emerging markets, and the world economy has been preparing to expect the first interest rate in more than a decade. These tight monetary conditions have led America to reduce capital flows to big emerging economies to a rising dollar. Its harder for firms and governments with dollar dominated loans to repay.
The Global economy is just in the middle of this significant transition. That is, as rich economies try to normalize policy, China seeks to rebalance. It is a difficult transition for policymakers as they try to manage and markets wobbling under strain.
The GDP of China grew by 7.4% which is the slowest it has experienced in 24 years. It is also the first time in this century the GDP has fallen short of the official target. There are also speculations to the fact that China can hit this years lower targets of 7%.There has been a string of interventions by policymakers which include shock devaluation of the Chinese Yuan but still the growth engine appears to be spluttering.
The second question is whether investors should worry. It was not unlikely for Chinas stock market to fall considering the dizzying climb in the first half of the year. , however, important to note that, the Shanghai Composite is still up 43% on its level of a year ago. The knock on effects from the market turmoil should be limited in the short run as small of the countys wealth is kept as shares. Most of its wealth is in property, the market for which has stabilized considerably in recent months. Since China is yet to unleash its potent interventions, it has room to cut reserve requirements at banks for instance.
In addition, its unlikely that there can be a recurrence of the 1997 Asian financial crisis as governments are in far better shape to weather these sorts of economic climate. Trouble in the late 1990s was triggered by currency pegs which have been replaced by floating-rate regimes, larger foreign exchange reserves and better financial times. The mispricing of the entire classes of risk assets and how interconnected they are to the vulnerable financial institutions that fueled the panic in 2008 are all absent.
There is nonetheless good reason for concern, if not for panic. We can ask some fundamental questions about china considering the economy accounts for about 15% of the global GDP and around half of the global growth. Chinas ability to manage market gyrations and animal spirits is to question suggesting that a decent Japanese style is a possibility. The sharp Chinese slowdown may grow of the government reacted to market turmoil by ending the process of structural reform which facilitates rebalancing.
As emerging markets falter and China rebalances, rich economies are left as lone engines for economic growth. This is a worrying prospect as Europes recovery remains fragile and export dependent. America economy, however, is more robust. But while Americas banks are healthier and consumers less indebted then they were ten years ago, their economy accounts for a smaller share of global GDP than it did in the 1990s and 2000s.In those years, the American household was often relied as the global shopper of last resort.
Investors in China have increasingly focused on diversifying their assets and uncertainty over performance of the stock market is reinforcement to this. Evidence indicates that Chinese buyers have intensified their interest in safe haven global property markets as due to market volatility.
In regard to the wider housing market, the prospect of interest rates staying in their record low for long should support demand and buoy prices. Events in China have little impact on commercial property. As an investor, you have to look through this and stay in course otherwise getting distracted by the movement in markets may be dangerous for the investor.
Shares and pensions
All European markets have been buffeted by the dramatic swings in Chinas exchanges. Almost a figure of 74 billion pounds was wiped off the FTSE 100 index on the worst day of that week. It tumbled 4.7% following Black Monday. However, following the emergency measures by Chinas policy makers to shore up their rattled markets, the losses had been gotten over by the end of the week buoyed by bright economic news by the US. Financial advisers have advised pension savers who have money in shares not to worry of the short-term volatility rather focus on what longer term returns look like.
Two factors are considered important in the FTSE ups and downs. The first is the level of risk investors attach to shares. The sharp fall in Chinese stocks shook investors around the world prompting them to ditch assets that are deemed to be risky including shares and investing in the so-called havens like government bonds and gold. However, its the view of most assets that equities will remain to be attractive investments as the economy of the globe continues to recover albeit slowly. Another factor that will render equities more attractiveness is yields on assets such as bonds being low and commodity prices hovering around multi-year lows.
The second factor is the importance of mining and energy company shares in the FTSE shares. These suffer when there are worries in the rise of Chinese demand for commodities such as iron ore, oil and copper. If concerns intensify over the economic slowdown in China and the wider global growth, these sectors are likely to suffer losses and keep wider FTSE under intense pressure.
The latest turmoil in Chinese markets and the worry of global economic outlook provide further complication for bank monetary policy committees. For instance, there has been a heated debate when the policymakers at the bank of England opted to lift interest rates in the UK from their record low of 0.5% where they have been for the last six years.
Why is this rule so important?
The reason this rule is so important is because the more money you lose, the harder it is to get back the money. If you lose half of your investment, then you will need to double in the next one in order to get to your starting point. And while you try to get to your starting point, you are missing on the magical compound interest returns. This means that if your goals if financial freedom or early retirement, you are going to work exceptionally hard to earn the lost amount as well as make up for the compounding returns you missed out on.
In general sense, losing money is rather painful to any investor, however, small or large the amount is. However, when we gain the same amount of money, the nice feeling achieved doesnt quite outweigh the pain of the equivalent loss. This is a well-known loss aversion characteristic that is in majority of people; the feeling of loss is worse than the feeling of gain. Experts who have tried to work it out say its at least twice as bad if you lose.
Thus each and every individual wants to hear about growth of their investments rather than losses. The question we now ask ourselves is, how do we actually follow this rule?
Never losing money in investing
This rule sounds very uncompromising. However, every great investor has lost money in their tenure-often huge amounts. The reason these investors are still referred to as great is the fact that they learnt valuable lessons from their ordeals and the pain of those mistakes has prevented them from repeating.
Thus the answer to this question is avoiding big losses. Loss of money is part of the reality of investment as there are no guarantees in investing. However, there some proven ways to avoid making big losses and giving yourself the best chance to follow Warren Buffet rule without making your own losses.
Operating within your circle of competence (stick to what you know).
Avoid investing in rare earth exploration companies and biotech stocks especially when you do not know what they do. Instead, follow Warren Buffetts footsteps and stick to what you know. However, you are encouraged to expand your circle of competence.
Diversify your portfolio to your advantage
While diversifying, do not just run out and purchase hundreds of shares you do not know anything about. A consideration should be done on the impact it would have on you is some of your current investments were wiped out and plan for such an occurrence.
Take advantage of stop-orders when purchasing shares.
It means when you are doing purchases, decide the maximum amount of loss your prepared to take (for example, 15%) and prepare a sales order before even the scenario occurs. There mixed reactions on this view around the world. Thus, it comes down to whether it suits your own plan and style.
Develop the right habits, mindset and behavior of a successful investor.
This is considered one of the biggest downfalls of most investors. Greed, fear, lack of patience, overconfidence are some of the attributes of this aspect. Though you might have the best plan and found the best investment, you would not get far if you have some of this attributes.
Develop your own criteria and a checklist of your investments.
This is a good method of getting better control of your investment decisions and results, understanding what works and refine your problems over time. Thus you minimize the idea of chasing the next idea or strategy which will not work in the long run. An investor who has his own checklist also increases their chance of sticking with what they know.
Planning for worst case scenarios in advance.
Its prudent to be fully prepared in case you f...
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