Falling markets a stark reminder that what goes up can come down

Last month, the headlines were littered with references to ‘new record highs’ as the US and UK stock markets – not to mention Bitcoin – continued their march upwards. The Dow Jones Industrial Index (a measure of the US stock market) took just seven days to rocket from 25,000 to 26,000. Bitcoin roller-coastered between $12,000 and $17,000 dollars, as speculators used credit cards to buy into the craze.

Fast forward to this week and the headlines are now talking about “plunging stock markets” and “largest one-day points fall in history”, while Bitcoin fell as low as $6,900.

While Bitcoin is a disaster waiting to happen in our view, the market falls are less of a concern. Here we put the volatility of the past few days into perspective:

What caused stock markets to fall?

Up until this week, the US stock market, as measured by another index, the S&P 500, had gone more than 400 days without a 5% fall. This was well beyond the long-term average of just 92 days. This, coupled with the fact that valuations were getting very high and we are almost nine years into a bull market meant a correction of sorts was long overdue. The 1,175 points fall in the Dow Jones was its largest in history but, as I said earlier, it had risen by 1,000 points just a few days previously.

The initial sell-off was initiated by better-than-expected US wage growth and employment numbers. Rather than focusing on the positives, investors appear to have fixated on a potential future downturn that may be sparked by faster and steeper interest rate rises.

Is this the start of a bear market?

Fundamentally, we don’t believe anything has changed. Company earnings have been strong and the global economy is doing well. However, as we mentioned in our piece on how the experts pick funds last month, there has been a growing danger of a market ‘melt-up’ – when stock markets rise very quickly before experiencing a correction. We believe this is what happened. In our opinion this current selling is to do with technical, rather than fundamental, reasons. We were due a correction and now we have got one.

What action should investors take?

In our view investors should continue to pursue their long-term strategy and resist the temptation to make short-term, knee-jerk reactions. At this stage of the cycle, the money is made by keeping your head when others are losing theirs.

The falls do serve as a timely reminder that investments can go down as well as up. As the end of the tax year fast approaches, and investors are wondering where to invest their ISA allowances, now is as good a time as ever to review your portfolio and make sure the level of diversification is adequate for your needs.

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views of the author and any people interviewed are their own and do not constitute financial advice.