Stock markets will always tumble thanks to emotional investors. Stay the course and profit

Telegraph

4 hours ago

Questor is The Telegraph's stock-picking column, helping you decode the markets and offering insights on where to invest.
Stock market investors have been left reeling by the exceptionally high levels of volatility that have been present over recent months.
The most notable source was the announcement of significant tariffs by the US, swiftly followed by protectionist policies from China, the EU and elsewhere, which prompted a sudden slump in share prices in early April.
While the stock market has enjoyed a broad recovery since then, its intraday volatility has remained relatively high, as investors continue to react to ongoing news regarding the potential for additional barriers to trade.
In the short run, it would be unsurprising if share prices continue to fluctuate wildly – after all, geopolitical risks remain elevated. This means investors are likely to find the task of estimating future company performance even more difficult than usual, with government policy seemingly subject to change on a whim.
The prospect of further heightened volatility could dissuade some investors from buying and holding shares. In Questor's view, this is an entirely logical viewpoint for those individuals who have a short-term horizon.
However, investors who have a long-term horizon, which this column defines as a decade or more, should not view heightened stock market volatility as a problem. Put simply, it does not equate to a greater chance of permanent capital loss. This is because a company's share price and financial performance are not necessarily closely linked over the short run.
Rather, short-term share price movements are largely a reflection of market sentiment that, in turn, is subject to ebbs and flows based on highly changeable – and often irrational – investor emotions. They can cause wild share price swings that bear little, if any, resemblance to a company's financial standing.
Indeed, even the most financially sound businesses in the FTSE 100 index have seen their share prices slump from time to time.
Long-term investors who simply hold onto their positions during periods of elevated stock market volatility will, of course, experience temporary paper losses. But providing they stay the course, the stock market's past performance suggests they can expect to enjoy a recovery and capital gains over the long run.
Indeed, the FTSE 100 index has delivered excellent returns despite its frequent bouts of heightened volatility. Since its inception in 1984, a period which includes the dot-com bubble, global financial crisis and Covid pandemic, it has produced an annualised total return of around 8pc.
At the time of these events, it was difficult to see a clear path to recovery for the stock market. Many long-term investors therefore sold out of shares, and determined that other assets offered a better risk/reward opportunity. But the FTSE 100 index not only returned to its pre-crisis highs following each of those events, it has consistently broken records, including several this year.
In the future, the stock market is very likely to follow a similar pattern of high long-term returns interspersed with periods of elevated volatility. In Questor's view, investors in shares must ultimately accept that the former can never realistically be achieved without experiencing the latter.
It could be argued, moreover, that heightened stock market volatility should be viewed in a positive light by long-term investors. In many cases, they are net buyers of shares given their extended time horizon.
Periods of elevated volatility provide opportunities to buy high-quality companies at lower prices than would normally be the case, with their market valuations sometimes considerably below their intrinsic values.
Of course, this does not mean that investors should seek to time the market by waiting for periods of temporary decline before buying shares. However, it highlights that the stock market's inherent volatility could prove to be a surprisingly useful ally that leads to higher returns over the long run.