“As long as the music is playing, you’ve to get up and dance,” Chuck Prince, CEO of Citigroup, once quipped. “And we are still dancing.”

He said this on the eve of the Great Recession, when banks were still putting ever higher chips on ever riskier financial bets. When eventually hell broke loose and Citi, like many other global financial institutions, went bust under a burden of stupefying leverage, this quote came back to hound him. It epitomised the recklessness of casino bankers gambling away the fortunes of millions of taxpayers. The tsunami of monetary destruction was such that when the music stopped all chairs were found missing.

Putting aside questions of regulatory oversight, capital adequacy and the role of banks in society at large, his comment is less profane than it had sounded at the time. We retail investors do behave in a very similar fashion: as long as markets are expanding we leave our money on the table. It is not only hard to watch others making good money while we ourselves stay timidly on the sidelines, it is also economically unwise.

Stock markets certainly have the nasty habit of crashing on a regular basis and it would be wonderful to know with certainty when they do. We all could cash out in time. Yet it would be necessary to know with equal certainty when they would start rising again. Otherwise we’d forego all possible gains.

It is not only that we lack such clairvoyance. It would do us no good even if we all knew how things will turn out.Nobody would buy and nobody would sell and markets would seize to function. As correct timing is impossible, moving in and out of markets at the slightest sign of stress is a costly and unsatisfying affair.

And it ignores the core wisdom of prudent investment: the magic of compounding. Savings which are idle will never grow, while regular, even modest gains will grow exponentially over time. If we’d manage to realise a dividend or interest income of five per cent per annum, our savings would double in less than 15 years. And then double again. And again if we had been wise enough – or affluent enough – to start saving at an early age.

That said, we should not throw caution to the wind. The current stock market boom in the US – worryingly already the longest in history – shows unmistakable signs of exuberance. Fed by Trumpian tax gifts and seemingly ever rising profit margins, share prices have reached improbable price/earnings ratios. Companies, lured by years of historically abnormally-low interest rates, have taken on debt exceeding levels not even seen before the financial crisis.

As interest rates are on the rise again, their indebtedness will not only be a growing cost burden for these corporations. Their stock valuations, representing future income streams, will come under mathematical pressure: today’s stock prices, calculated (discounted) on the basis of still low interest rates, will melt once interest rates rise more substantially. This will affect high-dividend-paying stocks more than others, and growth stocks with little to no income, their value model desperately depending on the debt and stock markets.

We should move into defensive investments like healthcare, pharmaceuticals, infrastructure or utilities

Geopolitical risks, like Trump’s trade war swagger and his insistence on levying ever more embargos on major oil producing countries like Russia and Iran, risk harshly dampening economic growth. Galloping tariffs on trade, disruption of supply chains and rising oil and metal prices will stifle sales – and will fuel inflation.

Foreshocks of what can be expected have been witnessed in January and October this year. Worries on an about-turn in corporate profitability and the extraordinary indebtedness of corporations, consumers and countries caused share prices to drop sharply and on a global basis. For many it looked like an infliction point. Tech high-fliers like Amazon and Alphabet (Google), the most popular investment fad in 2018, suffered to a disproportionally greater degree than manufacturers and the service industry.

Should we – regardless – stay calm and remain fully invested until the storm forming on the horizon has wreaked havoc and decimated our once so promising investments?

This is hard to argue. Investors in the Japanese stock market who lived through the slump of the 1990s would still be nursing their losses today. Collectively the share prices of Japanese corporations have never again reached the heights of those boom years. A loss of 50 per cent needs a rise of 100 per cent just to be back to square one.

Although US shares have so far always managed to reach new highs even after their most severe slumps, this cannot be taken as a given. And it is of little solace that over the long term stocks will always outperform, as we are told. We may not live long enough to see the light of that day.

Should we more actively diversify? Should we put money in commodities, into emerging markets, shift into bonds, hoard more gold?

Sadly, there’s nowhere to hide. In moments of stress all asset classes will eventually move in tandem – a phenomenon we quite cluelessly call ‘risk-on, risk-off’, meaning that, when panic spreads, the slump will be universal. (A note of caution: do not underestimate the risks of our home market. Our ‘Casino della Borsa’ with its handful of SME companies duplicates the all-Maltese business model of real estate, tax sheltering and tourism. Should we hit bad times Maltese shares will do so even quicker.)

Even cash holdings could be a risky undertaking. Ask Cypriot savers how they felt after their accounts had been raided by the very same banks which they had trusted over many years.

We will have to make our peace with the coming crisis. We will have to increasingly sell those bonds or shares where we believe that the companies we have trusted with our money will face serious difficulties to succeed. We will have to cut the most alarming losses and we will have to start buying again when we see that valuations have become too low for our convictions. We have to buy bonds when we can live with the level of interest income they pay even when tomorrow someone may offer more. We’ll have to be able to trust the credit-worthiness of the borrower, hoping that rising interest rates will not strangle it.

It is certainly no sin to keep interest-paying bonds until they mature: as long as we do not trade in and out of bonds, those paper losses brought upon us by higher interest rates will be irrelevant. It may be the time now to look more critically at Exchange Traded Funds which only ride high on the upside.

We should buy real estate now only when we need a home, and not for investment purposes. We should eschew more exotic investment ideas, particularly when we don’t understand them. We should move into defensive investments like healthcare, pharmaceuticals, infrastructure or utilities, as their income will be less affected by consumers tightening their purses.

We have to see a doctor, after all, and we have to pass the toll bridge – as long as we managed to hold on to our job, that is. 

In a world where we are tossed by the collective judgements of others which we try to second-guess, we should be prudent enough to hold on to the magic of compounding; and we should always remember, even when financial experts will try to convince us otherwise: there’s no get-out-of-jail-free card. We will have to sit it out, bruises and all.

Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.

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