People tend to compartmentalise new information according to existing patterns. Behavioural economists refer to this phenomenon as “framing”. Without framing, all new information would need to be assessed from square one, followed by the development and evaluation of potential future scenarios. Our brain would be permanently in overdrive. However, framing is not a subliminal tool for achieving a one-hundred percent accuracy rate; rather, it serves as self-protection. For conclusions from the past to be applied reliably to the future, it is necessary that there be sufficient grounds and comparable circumstances to do so, otherwise one can simply dismiss the previous patterns. So what facts about COVID-19 are currently known?
The coincidence of these unique factors makes it clear that no past pattern can be drawn on to arrive at a prognosis for the future. Nobody knows how things will proceed, as numerous questions remain open:
Given these factors, it is a possible conjecture that a positive just as well as a negative scenario lies in store for the financial markets. Optimists who, in response to the typical knee-jerk reaction of “buy-the-dip”, have been snapping up stocks since their 23 March lows, and who now feel vindicated by the interim recovery, will most certainly take a positive view of today’s circumstances. Those investors are mainly taking a hint from the recovery that followed the 2008-2009 financial crisis as well as their conviction that “governments and central banks will fix it”. As at the time, the logic here states that there is a huge amount of excess liquidity in the system and hence the search for yield will favour risky investments (i.e. stocks), as they offer the prospect of higher returns. However, if you take a downbeat view of the foregoing questions, you can only rub your eyes in wonderment at the recent reflex rally. Believe it or not, despite the fact that share buyback programmes and dividends were halted or slashed en masse and many companies are still unable to offer any sort of an outlook, more than half of the stock market losses have meanwhile been recouped. Be that as it may, though, not only job security but also new codes of conduct will influence consumption for years to come. What if this was just the first of many lockdowns?
First of all, investors need to take a more disciplined approach. Regardless of whether you embrace the optimistic or pessimistic scenario, a plan should be in place before you make the first move. At what level might it be best to sell; what should be done if prices run counter to your expectations? For many investors, these good intentions ultimately fail, albeit mainly due to psychological behavioural patterns. And this is precisely where convertible bonds come into play: they take away the psychological pressure. If the underlying share price declines, the associated convertible bonds lose less than the stock as these instruments become more and more bond-like in their nature. Hence the normal human impulse to sell the position decreases.
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