Some investors are getting nervous as stock markets here and in the US bump around their all-time highs. Newspaper reports are beginning to speculate that a correction may be around the corner and we are receiving increasing numbers of queries from clients about what this means for their investments.
Let us start by saying that small corrections are very hard to foresee and, generally speaking, when they happen they should be welcomed; they provide buying opportunities to add to portfolios at a better price. But renowned fund manager Peter Lynch is quoted as saying “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
IS THAT TRUE? IS IT BETTER TO STAY PUT AND RIDE OUT THE PEAKS AND TROUGHS OR TRY AND MOVE INTO AND OUT OF RAPIDLY FLUCTUATING MARKETS?
The answer is somewhere between the two. We were pretty pleased by the decisions we made surrounding the 2008 financial crisis, by which I mean that we were underweight equities in 2008 and overweight equities in the sharp recovery of 2009. We didn’t, however, completely sell out of stocks in 2008 because while the balance of risks was tilted against them, any number of actions by policymakers could have meant the rally came earlier. Holding too much cash when the stock market rallies can cause the immense damage to achieving financial objectives. This is particularly the case for long-term investors. Once you have missed out on a strong performance, it can be very difficult to make up the lost ground, particularly after inflation is also taken into account.
Our analysis of a balanced portfolio benchmark, looking back over the past 20 years, makes a clear case for remaining invested. Even around deeply troublesome periods for the market, it remains the best tactic over the long term.
Missing only the best five days in the market in the past 20 years would have led to a 23% lower overall return. Missing the best ten days would have reduced returns by a staggering 40%. Conversely, missing the 20 worst days would have led to double the returns of staying invested all along.
So we are always looking to take decisions which should enhance the return you receive over time from your portfolio.
But, equally, we recognise that it is all but impossible to time the market so perfectly, even with the best forecasting skills. So we try to ensure any misjudgements we make don’t jeopardise your investment objectives.
HOW DO WE APPLY THAT NOW?
What we can say is that large corrections, or severe ‘bear’ markets, are usually associated with US recessions. And while recessions are relatively hard to foresee, we do have indicators which we use to forecast roughly when they are likely to occur.
Currently, our analysis suggests that the US is relatively late in its economic cycle, but is still two or three years away from a recession. Although we expect a mid-cycle slowdown this year, it is likely that there is time to profit ahead of any big downturn. Indeed, historical analysis shows that some of the best years to invest are just ahead of market highs.
The best year to invest in the past 20 years was 1998, just a year before the FTSE 100 peaked, two years before the infamous tech crash of March 2000, and three years before the deep recession starting in 2001. This serves as a good reminder that you need to be incredibly accurate with your timing to make selling out of the market worthwhile. Even those who invested in 2000, when the market crashed, would have seen their money more than double.
Looking at the more recent bear market surrounding the financial crisis in 2008, once again, you would need to have been incredibly prescient to time investments correctly. The best year to invest was 2009, when the market bottomed, as you might expect. But it was only marginally better than investing in 2006 and remaining invested, even though this was just a couple of years before the crisis and only a year before the credit crunch began.
Rest assured our experienced analysts are constantly monitoring the market and economic data, looking to make some judgement calls to move money from one asset to another to capitalise on market sentiment. This tactic has served us well and we have outperformed our benchmark index in 11 out of the last 13 years, through judicious use of our award-winning research and asset allocation strategies.
Right now, therefore, we judge it to be better to stay invested, and allow our investment managers to take advantage of undervalued shares or switch into alternative assets on a selective basis - as and when market conditions permit - to generate additional returns for our client portfolios.
WHAT DOES THIS MEAN FOR CHARITIES?
It is a natural point of discussion at this stage of the investment cycle, when returns have been strong for some time and trustees are wondering if a dip is to come and, if so, when.
Trustees have to balance the obligations to today’s beneficiaries with those of the future. In doing so, there can be, as the figures above show, a serious opportunity cost in ‘running for hills’ based on a potential or cyclical event which may not occur. At the same time, their obligations and commitment are serious and are taken as such.
They are also not all the same. Grant making foundations and trusts, who have generally a very long or eternal time horizon, may have a different perspective to those providing essential service where the investment income (and capital) forms part of a multi-faceted budgeting and expenditure plan.
Having the right long-term policy in place is key. One of the sections that should feature in the Investment Policy Statement (obligatory for those with a discretionary manager under the Charity Commission jurisdiction and best practice generally for all charity investors) is time horizon. If you have a very long investment time horizon and can tolerate volatility in the markets in order to be invested in a balanced portfolio that will produce your annual income, then you should be more comfortable than those with shorter horizons or specific near-term obligations. Another IPS section confirms the frequency with which the policy will be reviewed. No matter how frequently within the policy (often annually), we would always advocate more regular discussion with the investment managers at times of uncertainty.
Guy Foster Head Of Research firstname.lastname@example.org
The value of investments can fall and you may get back less than you invested.
Past performance is not a guide to future performance.
The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.
No investment is suitable in all cases and if you have any doubts as to an investment’s suitability then you should contact us.
If you invest in currencies other than your own, fluctuations in currency value will mean that the value of your investment will move independently of the underlying asset.
The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd.