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Reading the Tea Leaves

September 30, 2017

Following a recent presentation, I thought to grab a couple of very quick snippets. These are both very good examples of past returns reflecting what we can expect for tomorrow – not specifically in terms of the result, but in terms of the journey.

 

The first image reflects the average cash balances of Fund Managers in the US between 2001 & 2017. The idea is to match how much cash they hold, relative to the advance or retreat of the S&P500 (the index of America’s largest 500 companies). Clearly on market dips, there is more cash being held.  Cash reduces and markets rally – except for 2017. This may be the Donald Trump effect. It tells me that Fund Managers remain cautious, while Mum and Dad investors are pushing more capital into the markets. That’s also a signal.

The next observation is in regard to the S&P500 itself.

 

Tracking from 2001, I suspect that large dip early in the piece reflects the market reaction to the World Trade Centre disaster in September 2001. There was a quick financial response and recovery, but uncertainty then took hold and markets fell back until enough confidence returned for businesses and investors to see the world again as “normal”. We then see a sustained rally.

 

What drove that recovery was cheap lending, over building and continued technology advancement; which lead to the next crash. The Global Financial Crisis (later to be called the Great Recession) took away all that ground (and then some more) to leave the US share market in tatters by 2009. The only worse place to have invested was housing and credit.

 

Then by mid 2009, on the back of an experiment known as ‘Quantitative Easing’ and a new President in the White Houseouse, the market staged a recovery. That momentum continues. 

 

Having invested mid 2001, the investor who held their nerve through the carnage is today up 5%pa, excluding dividends. Not great, but by no means a disaster! Certainly a better result than having held a rolling Term Deposit over the same period. Being brave and buying more on the dip would have been the most ideal path forward. Sitting tight for the recovery was certainly better than selling, if it meant to realise a loss and then wonder again when to re-join, as the early gains are usually the biggest.

 

One more picture, shown below – a Bear Market Risk Indicator:

 

The blue bars are recessions, or bear markets. The graphic lines are leading market indicators. No one knows when they will turn downward, nor the speed of the downward trajectory (usually very quick). And it’s too hard to tell if it’s a permanent shift down, or just another tweak before reaching new heights.

 

We can see two very large recent “tweaks” in 2000/2001/2002 and then again in 2007/2008/2009. Remember 1987 – the great share market crash?… It’s the thin blue line between 1980 and 1990 – a small tweak, on the way to all new highs.

The other point on this table is to question if we are nearing the next “big” tweak. There does seem to be a natural ceiling to these things and today we’re approaching it, and yet – the travel from here to the highest point could still well be some very high returns. We also know that the alternative places to invest are equally as expensive (real estate, fixed interest) and we know that if inflation is on the way back, then cash is not a long term friend.

 

So what to do?

 

Above all else, we must buy quality that will last the test of time, not be over-weighted (if we can’t cope with the volatility), and be well-diversified.

 

And one final point - “passive” investing rides the wave up and down, “active” offers a chance to step off.

 

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.

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