Taking the rough with the smooth

Despite the UK economy doing well, the stock market has seen further falls this week, since the peaks reached in September. Revised figures from the Office for National Statistics (ONS) show that the economy grew slightly faster than first thought in the second quarter of 2014, up 0.9% rather than 0.8%. The ONS figures also show that the UK economy overtook its pre-recession peak earlier than thought, surpassing it in the third quarter of 2013 rather than the second quarter of 2014 as previously stated.

Part of the stock market falls are paradoxically just because the economies in the US and UK are doing well. This is due to the talk about interest rate rises both sides of the pond. Logically it should be good news for company earnings and share prices that the economy is getting stronger but tighter policies on rates would mean that there would not be so much cheap money floating around the system and so less upward pressure on shares.

Oddly, bad economic news can have the opposite effect and lead to market rises, because a weak recovery would mean that central banks would need to keep pumping money in. 

Of course, possible interest rate rises are only part of the current equation. We are in a global economy and news around the economic world is not sounding great, with the IMF cutting its global growth forecast. Chinese growth is still slowing and as both the IMF and the Chancellor George Osborne have warned, the Eurozone could well slip back into recession. As both these are important markets for the UK, they could certainly impact upon the UK economy, which could see a slowdown in growth.

In addition there are various geopolitical issues out there that are creating uncertainty in the markets. Whilst the tensions in Ukraine have eased somewhat, they are still rumbling along in the background and the IS situation in the Middle East is a major concern. Short term, these factors are probably helping to send the markets lower, although it has been pointed out elsewhere that geopolitical tensions have minimal impact on medium to long-term market performance. Closer to home too, the UKIP by-election win has probably caused a few jitters.

The upshot of all this is that European and US stock markets have experienced sharp falls this week. The FTSE 100 closed the week 1.4% down on 6339.97, a 12-month low. In the US, the Dow Jones saw its biggest one-day fall of the year yesterday and fell another 0.7% today to close at 16,659.25, losing all the gains it had made this year. The Dax in Germany saw big falls, whilst the Cac-40 in France fell to its lowest level this year.

Many bears have been talking about a correction for some time now and there hasn’t been a real correction for about 18 months. In that sense, the current falls are probably well overdue. Despite investing being a long-term game, investors naturally overreact to short-term sentiment, leading many to buy at the top of the market and sell low as markets fall. As investors, it is understandable that short-term worries come to the fore but it is important always to take a long-term view. 

The current situation however presents buying opportunities at lower prices – and right now, the FTSE 100 does not look overvalued and is not looking overbought either. The current situation could also see the first rise in UK interest rates recede further into the distance, thus helping the markets.

In moments such as these, equity income funds can be a good option for many investors, depending on your circumstances and financial objectives. Alternatively, you can adopt the smoothing approach called pound cost averaging, buying into the markets on a regular basis via a regular savings plan. By adopting such an approach, when share prices are low you end up buying more shares, which will be good news when the stock markets start to rise again.

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