Shares digital

The stock market is very much in a rocky patch at present and even the term volatile doesn’t seem to really do it justice. But then it’s been a volatile year in truth. From just over 6,000 at the beginning of 2007, the FTSE 100 leapt to over 6,400, plunged almost all the way back again before rallying to over 6,200. Then down it went again, only barely avoiding crashing through that psychologically important 6,000 barrier. And all this before the end of March.

Since then the movements of the UK’s benchmark index have become increasingly pronounced and prolonged, as this year chart shows.

If this was the course of a passenger flight, we’d have all lost our dinners long before now.

But the way in which we react to such trying circumstances may go far deeper than a hopeful hedging plan, bold bargain hunt or any other financial rocket science we can come up with.

I was flicking through some research notes, which tend to accumulate on my desk, when I came across the Barclays Capital Equity-Gilt Study from earlier in the year, and it argues that we are all ‘programmed to find panic, and indeed the opposite condition of complacency, infectious.’

Apparently, millions of years of evolution have taught us that, if we’re to survive, we should instinctively run at the first sign of danger. Had our ancient ancestors stood about analysing the probability that the Sabre-toothed tiger over there would attack and eat them, none of us would be here today.

In today’s financial jungle, the wild beast is volatility. It’s the danger that triggers the flashing warning lights of our in-built survival instincts, and the greater the volatility, the greater the returns we expect from shares as a reward for facing it head on, and the less we are willing to pay for stocks in the first place. And boy, are the warning lights flashing now.

But as the equity-gilt study reminds us, if you can stick around for long enough the positive returns from investing in the stock market are more or less guaranteed. It shows that there hasn’t been a single 23-year period since 1899 when shares have not risen. Over 18-year periods, equities have beaten cash 99% of the time, and they’ve done better than gilts more than nine times out of ten over the same timescale. This also implies that equities stand a significant chance of beating bonds and property over the next ten years as well.

Of course, in the short-term, there is still plenty to worry us. Making a bad call today won’t make you the main course of any feast, but it can mean losing considerable amounts of money. And this affects the way in which we assess the effects of future turbulence too, because no one knows what the future will bring.

However, this also means we tend to extrapolate the past into the future, because it’s basically the only guideline we have, and this means that, at the end of any period of volatility, share prices are very likely to end up relatively cheap.

Which brings us back to where we started, at the end of a highly volatile year. It’s true, the stock market roller-coaster has probably not yet run its full course and we may well hand the New Year a jittery welcome. But after ten years in which the market has soared, slumped and recovered sharply, share prices are barely more expensive than they were at the end of the bear market in 2003.

Barclays analysis suggests that the best way to weather stormy equity markets is to embrace their uneven returns, not run from them. Time may well show that the only investors that get trampled by the march of volatility are the short-term speculators.