April 17 - Leonardo Siligato
Inflation doesn't only make your bills fatter. It also cuts companies' bottom lines. Here's how.
Wouldn’t it be great if we didn’t have wars, corporate greed, elections and crazy-ass elected officials? Stock markets would just keep going up and life would be nice and easy. But, it would also be very boring! Whilst learning to invest during risky times is a necessity, it can also be exciting. Why? Because volatility brings opportunity!
But remember that our first priority is to protect our hard-earned profits. As Warren Buffett’s famous rules of investing states: “Don’t lose money. Rule number 2? Follow rule number 1.” Here are a few more tips on how to build a stock portfolio Warren Buffett would approve of.
So, what constitutes risky times and which markets can we invest in? Time to to get down and dirty…
In most cases, risky times are caused by events that change the norm. There are a gazillion scenarios, so let’s get specific and look at some major risky events:
Markets like pro-business governments whose actions are likely to prop up the stock market. If anyone or anything looks like they’ll upset that norm, then the markets and investors don’t like it.
Think of Brexit. The United Kingdom leaving the European Union is a huge change after 40 years in the EU. It also adds a lot of political uncertainty as to what is going to happen next, especially for big businesses that rely on free access to markets. The markets didn’t take this well. For much of 2014 and 2015, the UK stock market and British pound fell sharply.
In recent years, there have also been the French elections and US elections which hurt their currencies and stock markets. Even issues in the Middle East affected oil prices as supply routes were disrupted.
Over time, it’s natural for prices of goods and services to rise. However, when those price increases start to become excessive, then it takes a toll on consumers as their spending power falls. Inflation can happen for any number of reasons. Maybe the price of oil goes up, causing energy companies to raise prices. Perhaps a currency has sunk so low that importing items from abroad now becomes a lot more expensive.
High inflation becomes risky as people stop buying things which hurts company profits and thus, employment.
Whilst deflation is less common, it happens when demand is so low that it leads to an excessive drop in prices. Japan’s so-called lost decade, between 1991 and 2001, started with a collapse in the stock market and housing market. That led to falling wages and lower demand, that resulted in lower prices.
Even a company can go through risky times if they’re hit with a profit warning, scandal, very high valuations or even just a lack of innovation, as in the case of Blackberry. In all these scenarios, not many people are looking to invest which compounds the problem for the company. No money is coming and everyone is cashing out.
So, how do you protect yourself during these risky times and what do people invest in during these periods? Let’s find out!
This is exciting stuff!
Are two markets enough for investment during risky times? Well, they are two markets that all hedge funds and institutional managers use to protect their clients’ portfolio – so yes! Heck, even governments invest in these markets for a rainy day…
Gold is the ultimate safe haven asset to invest in. Why? Much of it has to do with gold’s historical perception as a store of value. It’s something that can’t be manipulated by governments or governmental policy. Most importantly, if shit really hits the fan, you can melt gold down and use it as a currency to barter like in the old days. Good luck doing that with a £50 note!
Gold is also considered a safe haven asset because it is negatively correlated with other assets during times of market stress. When stock markets fall, gold tends to rise. When the US dollar crashes, gold tends to rise as it’s mainly priced in US dollars.
Gold to the rescue!
With most of the world’s most powerful and wealthiest storing money in Switzerland for tax purposes, no one dares to trouble them! Hence, it’s considered a safe haven. The Swiss government and financial system are highly stable, and the Swiss National Bank maintains a low rate of inflation. Switzerland has also managed to remain a neutral country, having not gone to war in more than 200 years.
But, let’s face it. There’s so much money in Swiss vaults that when things go tits up, people sell their assets to bring money back home. Those profits and losses are converted into their bank’s currency which also helps to push up the Swiss franc. The technical term is ‘repatriation of funds’.
Here is All You Need To Know About Currency Pairs, like the Swiss franc.
So how would you use these two markets to invest during risky times? Let’s have a look…
Hm, that’s one way!
By now, you know about the markets investors tend to flock to during risky times. So how do you put it all together? Let’s break it down:
Firstly, we’re not taking a break in the markets to go and trim the hedge. Oh no. We’re aiming to hedge our open positions that we don’t want to close. For example, say we’re long on a few stocks but don’t want to close them as we’re in for the long haul. However, the market may fall a little lower before it moves higher. What do we do?!
One strategy would be to find a negatively correlated instrument, like gold, and invest into that. As the stock market moves down, gold moves up (almost always!). So, in theory, our losses will be hedged against our profits in gold. All in theory, of course.
During risky times, we know the market is likely to be quite volatile with many up and down moves. One way to protect ourselves is to diversify our portfolio so it’s more balanced. We could have high-risk tech stocks in the mix with some more stable utility companies, as well as gold and Swiss francs. The opportunities are endless but having a plan to manage our portfolio risk is the main aim here.
So, there you have it folks, this is how to invest during risky times. The ballsiest amongst you may sometimes want to go for glory though – in which case, check out our tips and strategies for shorting stocks.
June 15 - Leonardo Siligato
Thinking about getting into oil trading? Here's why and how you should invest in oil, along with all the factors that affect the price of oil!
March 13 - Jitan Solanki
Fancy building a stock portfolio so you too can be named an oracle, or even a sage? Then check out these 4 must know rules...