Retreating market, skittish investors

IT IS not unusual for me to be asked how soon the local stock market will recover. That is a question I do not pretend I can answer and would love to meet anyone who can do so.

It seems to me that the performance of the stock market from 2015 to last year has given too many people a very distorted view of how markets in general, and stock markets in particular, work.

It seems that many investors do not acknowledge that risk is inherent to investing and that it is important to take steps to manage it. There are two types of risk: market risk, also called systematic risk; and specific risk, also called unsystematic risk.

Market risk refers to the risk of incurring losses due to factors that affect a market. So a stock price declines due to the overall decline of the stock market.

When the stock market declines generally, even the best stocks record price declines although profits may be good and the prospects for future profits may be positive. It is just that the better stocks tend not to decline as sharply as lesser-quality stocks.

By the same token, when the stock market is experiencing positive price movement, even lesser-quality stocks record price appreciation but, generally, below the level of the better stocks.

Specific risk is that associated with a particular stock. The price of the stock moves because of issues specific to the company. For example, consumers may choose to switch demand to a competing product, or internal problems may lead to the profits of the company declining. Diversification is the primary tool for managing specific risk.

There is sufficient evidence to show that stocks perform very well over the long term. If investors come to appreciate this, I doubt they would be as skittish as they tend to be when the market moves into negative territory. Short-term fluctuations are to be expected, and investors who do not have the capacity to tolerate them are those generally acknowledged to be risk adverse, or low-risk takers at best.

The Main Market Index of the Jamaica Stock Exchange provides very good reading of how the market has been faring. I have opted to present data on the period from the end of 2010 to the end of July 2020 and have also included the index at the end of July for the selected years to allow for comparison of one-year periods up to July 2020.

The figures show that after increasing at the end of 2011, the index declined for three consecutive years and increased every year from 2015 to 2019.

The position at the end of July for the period under consideration differed slightly. After advancing in 2011, it declined in 2012, increased in 2013, declined in 2014, and increased every year from 2015 to 2019 but declined in 2020. Overall, the index increased 567.84 per cent from the end of December 2014 to the end of December 2019 and 634.48 per cent from the end of July 2014 to the end of July 2019. It declined 27.36 per cent from the end of December 2019 to the end of July 2020 and 29.27 per cent from the end of July 2019 to the end of July 2020.

These are the closing values, in points, for the JSE Main Market Index for the months of July and December from year 2010 to 2020: The decline of the market became clear in the latter part of last year, but any hopes of a recovery were dashed by the onset of COVID-19, the pandemic, which is still having a broad negative impact on the local, regional, and international economy.

It did not give much warning, and its effects are expected to be long-lasting. Although some companies have reported good earnings, this is not so for the majority. To the extent that company profits are not expected to be robust, the performance of the stock market is not likely to be strong.

This is one unpleasant reality of investing in stocks: one event can turn the whole market dramatically overnight, and its effects can be farflung. Individual portfolios, pension funds, equity-linked insurance policies, unit trusts, mutual funds, indexed funds can get hurt seriously. But this, too, shall pass. The stock market is not for the faint-hearted. Neither is it for those impatient for wealth.

■ Oran A. Hall, principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email finviser.jm@gmail.com.