A Rocky Start
I’m not going to talk about China, US interest rates, oil, inflation, deflation or the price of fish. I’m going to talk about the sky falling or rather, it isn’t.
We invest in share and real estate markets with a long term view. We never invest with a six month view or indeed, a three year view, yet we all want positive returns in six months (and certainly in three years). As we know, investing can bring times when things just don’t work out as we planned.
We want to invest in companies or managers that show the greatest potential to outperform over the long term - that means “outperform” their peers in the long term. Do we really care what happens in the short term? I guess we do, because it can create much uncertainty and that can lead to bad decisions. So, we try to avoid fads, we try not to follow the crowd. We work for our clients.
Markets have been irregular (if there is ever such a thing as a ‘regular’ market!), because the shares and sectors that performed badly in previous years continued to underperform, while the shares that previously performed well continued to outperform. This is known as market trending. Generally last year’s winners don’t tend to perform as strongly in the following years; they simply don’t have the capacity to produce the same amount of performance. Equally, some businesses have strong growth and can continue to grow for a very long time. So on dips, we should seize the opportunity to increase the holdings in our favoured shares, while prices are lower than we imagine they should be. This approach reduces our average purchase price and increases the likelihood of a long term positive return. It’s neither gambling nor guess work and it is a brave investor who invests on a falling wave, yet history proves this is when the best returns are made… maybe not that particular year, maybe not even in three or four years, but in the longer term the certainty of doing well increases.
A good business with defendable cash flows and future earnings growth will be worth more in the future, but their share price today will be determined by the sentiment of sellers today and in that environment, the difference between real value and perceived value can be dramatically different.
Sitting on the right side of the fence
When market expectations are low the situation only needs slight improvement for share prices to rise. For shares trading on high valuations, the good news is already in the price and so a slight reversion means the price could tumble. We would much rather sit on the side that shows potential for significant price rises, not limited upside. But I confess, we can feel disheartened if the anticipated results take longer than planned (the price today still being set by what sellers are willing to accept, irrespective of what tomorrow brings).
Onwards and upwards
Today in the media we see lots of speculation. There are more ‘Bears’ (pessimists) than ‘Bulls’ (optimists). We have had five straight years of substantial gains, so not only is it normal for a pull-back but indeed, maybe desired. Valuation “bubbles” are not good for anyone, and in the long term they tend to lead to deeper recessions.
So, are markets over-valued? The ones that appear this way are bond markets (fixed interest) and residential property (if we are talking NZ). The NZ share market looks as highly valued as any in the western world (not as high as our real estate). I saw someone quote in the media recently the old: “return of capital is more important than the return on capital”. Hey I agree, but over what time frame?
As a practitioner, I don’t usually make short term predictions, because it is impossible to say exactly which shares will rise and which will fall, or when. We focus on the long term, what can be delivered over five years or more. Deep trends are what we look for, solid foundations and sensible diversification.
Our portfolios have endured periods of underperformance before and it will happen again. That’s the nature of investing; we have to suffer short-term pain for long-term gain. Over the long term, we expect outperformance. Don’t get me wrong, when I review the last month’s results there are a few in positive territory, but most are down slightly. When I review the last twelve months (including December and January) everyone is substantially ahead. So this is a message about sticking to the plan. Don’t ignore the Bears but, take some of what they ‘sell’ with a grain of salt.
We will continue to deliver over the long term, and in the short term we will seek to separate risks.
We will not put at risk all of an investor’s capital. If they have stated that they need to draw on that capital in the near or medium term, we will provision for that but, if it is only a part of their capital that is needed then, what of the next five, ten or twenty years? Will it matter in September 2024 if stock markets were down briefly in 2016? Maybe it will – but more likely, it won’t!
Financial markets were down (and some substantially) in: 1987, 1990, 1992, 1994, 2001, 2002, 2007, 2008 and 2011. Had we known we could have sold and been side-lined, but the problem then becomes; “when do we re-enter”? You see, after each of these falls financial markets did not just rise a little, they went substantially higher! And then down, and then up, and then down, and then up. But point to point over the long term, where do you imagine the investors who bought quality ended up?
If we miss the first few days of the rally, we’ve missed most of the recovery. Timing is everything and it is impossible. Sure, sometimes we get it right but usually, it is degrees of wrong. All we can precisely know ahead of time is what precisely happened yesterday. No one truly knows what tomorrow brings (despite what you read in the newspapers) and so, we have to plan for possibilities. Conversely, if we knew with complete certainty that the only way was up, we’d have everything in the market.
Good portfolio management is about the degree that we are “in” or “out”; but we’re not traders - that’s gambling! As investors, we acknowledge that sometimes we may choose to keep extra in cash or fixed income, especially if we feel more anxious about the immediate future, or if we know we need to be so positioned because our client’s circumstance is where the anticipated volatility or change is likely to occur.
The management of the degrees of exposure is what we call “Asset Allocation”. Scientifically we know over the long term we can more precisely predict the average annual return and likely volatility. The question should never be; “how we are positioned when markets are falling or rising”? The important question is; “are we positioned to best reflect our client’s personal circumstances”? Then, good investment selection is a natural extension of good portfolio management and timing won’t matter.
Tony Munro CFP AFA
The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.
A disclosure statement is available on request and free of charge.