As Donald Rumsfeld said, there are known knowns, the things we know we know and there are known unknowns, the things we know we do not know but there are also unknown unknowns, the things we do not know we do not know.
Recent events, such as the Thai government’s disastrous plan to try to control the country’s currency and the US government’s ban on online gambling, prove it is not only general economic issues such as interest rates and unemployment figures that can cause stockmarkets to plummet. Investors need to be aware that unpredictable events can also create havoc, even in established markets.
Investors generally understand they are increasing their risks by investing in emerging markets while most would feel at ease buying in the UK or US market. But the shock US decision to ban online gambling in July last year resulted in a significant stockmarket downturn and proved that even in established markets unpredictable events can create problems.
Informed Choice managing director Nick Bamford says most investors tend to be cautious, preferring to put money in their home markets rather than risking emerging markets.
But F&C global small companies fund manager Peter Erwins says investors need to be aware that established markets can also be volatile.
He says: “When the ban on US gambling was announced, it was a surprise because people had thought that the government had run out of time but they did it at the last minute.”
Bamford says: “You would expect more bizarre changes in emerging market funds where many countries may not have long-standing democratic governments so most investors are mainstream and prefer to invest within the UK economy.”
But he acknowledges that hasty government action and freak events such as hurricanes can affect any markets and have knock-on effects in other markets.
Blackadders director Keith Thomson says natural disasters of floods, hurricanes, etc, have increased in the last few years and says these devastating events often have a big impact on local and world markets.
However, some disasters do not necessarily cause market falls. Hurricane Katrina devastated New Orleans and dented the oil industry in the Gulf of Mexico. The day before Katrina hit, the Dow Jones closed at 10,450 but 11 days later, the market closed at 10,589, up 1.3 per cent. Interestingly, previous storms in the US, including hurricanes Andrew in 1992, Hugo in 1989 and Camille in 1969, had a similar effect.
Manmade shocks can also have effects on markets, with the 9/11 terrorist attacks being a prime example of the resilience of markets.
The New York Stock Exchange shut down for a week after 9/11 and the market fell by 14 per cent when trading resumed on September 17. But within a few weeks, markets had made their way back to pre-9/11 levels.
Fraud cases can also cause market upsets. The biggest case was, of course, Enron. When the massive fraud was uncovered, Enron collapsed and Enronitis followed, as the share prices of firms that worked directly with Enron or which were similar businesses plummeted as well.
Bamford says: “If there is a major UK company that is massaging the books it may suddenly be caught and will crash and burn. Regulation systems do not prevent that kind of thing happening and when they do happen they tend to be big ones.”
But Blackadders Keith Thomson believes market crashes can bring opportunities as they allow people to get into the market at a bargain price.
He says: “There was a default in 1997 when Barclays had decided to invest in a Russian bank which was pretty dodgy but the potential was fantas-tic so they decided to hedge that risk. The Russian bank collapsed but the hedge fund collapsed as well and lost around 250m and their share price halved. I bought a lot.”
Investors can handle the known knowns and try to prepare for the known unknowns but there will always be unknown unknowns that take the stockmarket by surprise.
Thomson considers that the best that investors can do is be familiar with the companies and markets in which they invest in and choose a fund manager they trust but diversify their stocks to spread the risk.
He says: “There are many things we cannot plan for, like a meteorite hitting the Earth, and statistics show that we are overdue for one but knowledge is power. The more you know, the more you will be prepared for the unexpected. Wherever you invest, it is based on the trust that the fund manager knows what he or she is doing and are not going to be taken for a ride. This is why you do not put all your eggs in one basket.”