It has been a worrying couple of weeks for stock market investors with exchanges around the world still looking decidedly unstable. Financial adviser Ian Lowes says all will be well if investors hold their nerve.

THE stock markets opened on Monday August 8, 2011, by reacting to two pieces of substantial news which had been made since the markets closed the previous Friday.

The first was that for the first time in modern history one of the ratings agencies – Standard & Poor’s – had downgraded US government debt from the coveted AAA rating to AA+ with a negative outlook. Also, that the European Central Bank (ECB) decided to take action to prevent a widening of the eurozone sovereign debt crisis by buying the government bonds of Italy and Spain.

While both items of news had been widely discussed, before the announcements, investors were already concerned with the inability of politicians and the central banks to come to any mutual agreement on how to solve the widening sovereign debt problems of the US and the eurozone. Which is why, even before the announcements, we had already seen significant corrections in global markets not least being the 10.5% fall in the FTSE by close of the stock market on Friday, August 6.

Not surprisingly, all the major stock markets took further hits on the Monday morning. By Tuesday the FTSE 100 had fallen through the 5,000 barrier – it had not been there for a year. All of which was enough to make investors’ eyes water.

Then for a moment this momentous news was lost behind coverage of the riots and criminal activity that broke out in London and quickly spread to other major cities in the UK. While pictures of buildings engulfed in flames and streets that became a battleground filled our television screens and the front pages of our newspapers, the drama playing out on the international stock markets for a moment was lost in the background.

By the time the police had regained control of the streets or the looters had realised their window of opportunity had passed, the stock markets were beginning to show signs of recovery.

What does all this mean for us as investors?

There is no doubt that the downgrading of US government debt is a major event, and will have ongoing repercussions that will affect global markets for the foreseeable future. How much, however, is open to question as can be seen from the fact that in the days that followed the credit ratings announcement, US government bond yields fell to all-time lows. Meaning that, paradoxically, investors looked to them as a safe haven over alternative investments.

While the ECB’s intervention was no real shock to the system, as it had been talked upon incessantly, previous comments by Jean Claude Trichet, the head of the ECB suggested the purchase of Spanish and Italian government bonds was anything but a popular decision with the central bank. This apparent failure to agree on a course of action without being taken to the twelfth hour, and the resulting short-term panic, resulted in a domino effect that created a herd-like selling mentality and forced major investors to shed stock, which in turn pushed markets further down and forced more investors to offload.

To explain the latter: most institutions when they give an investment mandate to a fund manager or asset management house have an eye to capital protection. As such they often stipulate in the mandate that should stocks fall in value by a certain percentage or reach a certain level, that the manager must sell the stock and look for a better buy.

As the stock markets fell, so these institutional parameters were reached. Fund managers were forced to sell out of the stocks as per their instructions. Many of these stocks will have been well-known names, the sell-off of which then sparked fears around the stock itself, which caused further panic selling, causing the price to drop further. This then affected fund managers whose mandate allowed them to hold the stock until a lower price was reached. They then had to sell, and so the spiral continued.

So where are we now? Very simply, we are where history shows stock markets have been many times before. And while past performance is no guide to the future, retracements of the markets are a function of those markets. The key for investors like you and me when such events occur is not to panic. Panic selling into falling markets crystallises losses.

Unlike many institutional investors, private individuals have the opportunity to take a long-term view of their holdings and so do not have to take a hit when these kinds of events occur. They can wait out the downturn and, if they have the means, even profit from them by investing into the markets when prices have fallen.

Massive sell-offs such as we have seen more often than not result in dramatic recovery in the stock markets for the very reason that stocks have been oversold.

As financial advisers we help successful investors not to panic, to stay calm, ride out the storms and to invest when the opportunities occur. Our belief is that now, unless more significant bad news is received, stock markets will pick up and we will see that history does indeed repeat itself.

Certainly, at time of writing, all the major indices are once more charting upwards.

Ian Lowes is managing director of Jesmond-based Lowes Financial Management