Oran Hall | The far-reaching effects of a weak stock market

Ordinary shares can be relied upon to yield very positive returns to investors over the long term, but, because stock markets are cyclical, there are periods when equities do not give positive returns to investors. In those periods, though, the markets provide good opportunities to savvy and patient investors who are prepared to invest judiciously.

Investors generally watch the movement of stock market indices to determine how well the stock market is doing. They love it when the indices advance because it means that stock prices are increasing. This does not mean that the prices of all the listed stocks are increasing. While some increase, others decrease.

The Jamaica Stock Exchange (JSE) uses weighed average indices. Stocks with the highest weights have the greatest impact on a particular index. Thus, the index can fall even if more stocks register increases in their prices than stocks that record price declines. This is why it is important to take note of the advance-decline ratio.

It is also important to take note of the market breath – the number of stocks that trade in a particular trading session. Also important is the trading volume. High volumes indicate that investors are quite engaged in the market, for there cannot be sellers without buyers.

Even when the market indices are falling consistently over a long time, there are days when the market rises and days when it falls. At the same time, measures such as the advance-decline ratio and market breath can indicate the level of life that the market has. Savvy investors know this and position themselves to capitalise on the re-bound because they recognise that falling stock prices do not necessarily mean that listed companies are generally performing poorly.

When stock prices are down, many people are affected negatively, even if it is temporary. Some are not even aware of this because they do not know that their money is invested in the market. For example, some people who buy life insurance policies and invest in collective investment schemes do not seem to know exactly where their money goes once it passes from them to the financial institution.

Individual investors are usually more aware. Even if they do not watch the market index, some take an interest in the movement of the prices of particular stocks – sometimes too much interest because of the panic it induces when prices are declining. Many investors find it difficult to see their money losing value. When the inevitable rebound comes, though, they find reason to smile.

Investors who opt for equity funds in unit trusts and mutual funds generally know that their funds are invested in diversified stock portfolios. This tends to offer some protection, but it does not guarantee that the value of the investment will at least be maintained. Investors in mixed funds get some protection from other instruments like bonds and money market securities, but can expect their investment to be negatively affected by declining stock prices, nonetheless.

Investors who opt to retain their investment in the collective investment schemes, like other equity investors, can expect their values to increase when the market rebounds. The investor who sells when prices are down can be adversely affected but has the option of moving those funds to other investment vehicles that are doing better.

Life insurance policies can also be affected negatively by declining stock prices. Equity-linked policies are a good example. Policy holders can be affected in several ways. Those desiring to convert units to cash may have to covert more units to realise the money they wish to derive from the policy. The preferred position is for policy holders to avoid converting units to cash.

For policies with the death benefit being the sum assured plus the investment value of the policy, lower equity values due to lower stock prices mean a lower pay-out to beneficiaries. Similarly, endowment policies, which are issued for a fixed period, are generally put at a disadvantage if they mature when the market is down.

Another category of policy holders that can be affected adversely is those who use the value of their policy as security for loans. Low stock prices reduce the value of the policy and how much the policy holder can borrow.

People who retire when the market is down are also at a disadvantage if their pension benefit is based on contributions to the pension fund plus the income and investment values, as happens with defined contribution plans. Members of defined benefit pension arrangements are not so affected as their pension is based on a formula that the employer is required to honour.

Investors can get some protection from falling stock prices in their local market by investing in other markets if they can get good advice and guidance. Further, good dividends can cushion some of the paper losses, so it makes sense to invest is companies that have a good record of paying dividends.

The good thing about low stock prices is that they do not last forever; stock markets rebound. It makes sense to look for the opportunities which inevitably present themselves when prices are down to benefit from the rebound.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. finviser.jm@gmail.com