Bob Homan: 'Don't stocks always go up in the end?'

August 13, 2024

Equity Financial markets

Bob Homan (foto credits Kees Rijken).jpg

_{This column was originally written in Dutch. This is an English translation.}

By Bob Homan, Head of the ING Investment Office

After a somewhat turbulent period on the stock exchange, stock prices fell sharply last Monday. People called, emailed and texted me, both mature and green, who wanted to know what we were going to do with our portfolios, but who were mainly looking for reassuring words.

I worked from home that day and had coffee with my twenty-year-old daughter in the afternoon. She asked if I was busy. I told her that there was panic on the stock markets and that many people were concerned about it. She is not particularly interested in the financial markets, but she did ask a very important question. 'Why are they so concerned? Don't stocks always go up in the end?'

Eventually I came up with an answer, but it still took me some effort. I wanted to talk about the pitfalls that behavioral finance focuses on, but I had recently come to expect that investors would be less likely to fall into these pitfalls due to all the attention and education on this subject. The answer is clear: probably not. People continue to do things in all areas of their lives that they know are not useful. The same goes for finances.

Things are going well as long as things are going well

In the end I told her the story about people who buy higher-yielding assets with cheaply borrowed money. A carry trade that works well as long as things go well, but must be unwound quickly if things go south. I talked about people setting up volatility trades, which work well until the market pulls back sharply, the volatility differentials between stocks largely disappear, and positions are unwound, leading to a significant acceleration of the move. And there are several examples of financial engineering that can amplify price movements.

Of course, as active investors we are not completely free: we try to beat the market with under- and overweightings and sometimes we sell something with the aim of buying it back at lower levels.

Feel free to call!

All in all, there are plenty of reasons why the markets will always continue to move significantly. At times of sharp declines, I will continue to reassure people and tell them that it is a buying opportunity if they are underinvested and otherwise to sit quietly. And answer that we do nothing with our portfolios at such times. But they could also have called my daughter for that answer.