Having recently taken advantage of the new pension freedoms, I am acutely aware of recent market declines. Behavioural finance experts give us pearls of wisdom such as staying focused, keeping level headed and not moving with the crowd. However, when it’s your own money on the line, it is very different. The thoughts I can offer are based on some practical guidelines learned over many years investing.
What I have discovered is that there is no magic formula, instead it is mostly common sense. You will have heard this before but it is worth repeating, it is impossible to time markets. I do not mean that investors cannot make good judgements, it’s just that precision in these matters is impossible. Luck is not a good substitute because it is difficult to repeat. Acting with precision is similar to arguing that you are a good shot because all your bullets hit the same spot but missed the target. In this context, I would suggest being approximately correct rather than precisely wrong. Putting money to work on bad days over a period of time is not a route to quick riches, but it goes a long way to generating long-term wealth creation.
When it comes to making predictions about the future, it is fundamentally about processing new information. We know for certain now, and have suspected for some time, that China is slowing.
This in itself is not a big surprise, because it follows the natural law of large numbers. After many years of growth helped by easy money and a weak US dollar, many emerging markets are finding sustaining growth difficult, more so when tailwinds turn to headwinds (such as a stronger US dollar and the possibility of rising rates). For emerging markets and commodities, no-one knows where the bottom is. Prices have adjusted, which takes some risk out, but still leaves investors with uncertainty.
My second suggestion would be to ask this question: ‘Am I correctly positioned for the risk I am willing and able to take?’
This means reverting back to the basics, asking: ‘what is the difference between risk and uncertainty?’
- Risk, as it was first articulated by Frank H. Knight in 1921, is something you can price.
- Uncertainty, on the other hand, is something that is hard to price.
Uncertainty is currently running at high levels, which means there is a risk of prices falling too far if uncertainty increases. Investors will be assessing price and drawing their own conclusions. In this context, it seems reasonable to assume that central banks in the West will keep policy loose and so keep interest rates low for longer and promote growth through stimulatory measures.
This means that once uncertainty reduces, investors will once again need to search for yield. Equities with strong balance sheets and business models resilient in the face of weaker demand for goods and services will be increasingly attractive, but credit spreads on bonds for badly-priced corporate debt will widen and this will hurt their share prices too.
While investors will be focused on making judgements on price, economists are now fixated on predicting the future path of the real economy. Will current events turn into a recession? I read recently that the US government produces data on 45,000 economic indicators each year and private data providers track as many as 4 million statistics. Since World War 2 there have been 11 recessions, which means that statistical econometric models have to choose from 4 million inputs to produce just 11 outputs. Need I say more…!
Pulling this together, it seems to me that:
- not being able to time markets;
- making sound judgements on price; and
- adjusting to new information
are all common sense.
This means investors should invest according to the level of risk suited to their circumstances, take a longer term perspective and utilise diversification to guard against the inability to make accurate predictions about the future.
Following Chris Leyland’s blog on Monday we have gathered together comments from our investment partners. They are well placed to take good long-term decisions and build risk aware portfolios, because they constantly adjust to new information as it unfolds.
Here’s what they had to say:
Goldman Sachs
“In the short term, we do see the potential for further market weakness and volatility as investors return from their summer holidays and this lackluster growth picture starts to improve (still our base case).
We maintain our asset allocations, including a slight overweight to equities in particular European and Japanese stocks …..and on the bond side we continue to keep the duration short as we a expect a very gradual increase in interests rates in the US and UK.”
SEI
“Looking through the current crisis, SEI believes that a number of key developed market economies will prove resilient and keep the global economy on course.”
7IM
“Despite chaotic markets, the global economic picture is reasonably positive, as good news from the US and Europe offsets bad news from commodities exporters and the oil industry.
Don’t be put off by markets – the world is not in bad shape.”
Schroders
“We would note that valuations of stockmarkets have become more attractive following the sell-offs we have seen, particularly in Europe. We are wary of the pitfalls of focusing too much on temporary volatility and note that such volatility can create opportunities for long-term investors.”
Threadneedle
“We are not in a structural crisis and opportunities are being uncovered by market declines.We do see interesting values emerging from this sell-off, but avoiding “value traps” will be crucial.”
Close Brothers
“While for now markets do not feel good, and could well head lower, we think that the magnitude of the moves, particularly in many developed market shares with little to no direct exposure to China, resource and emerging market factors, do not seem justified by fundamentals.”
Allianz
“..many equity markets, after a solid H1 results season, have fallen to more interesting levels with Europe now below 15x earnings and experiencing upgrades for the first time in 6 years.”
Therefore, the key messages are:
- Global growth is slowing but a recession seems unlikely with various stimulatory forces or actions likely to prevail (China cutting interest rates is an example)
- Valuations in many equity markets after the correction have improved
- Opportunities are appearing within market declines
- Active management and stock selection is now of more importance to avoid uncompetitive businesses (of course, passive trackers have no choice and must invest in poorly managed or highly-indebted businesses if they are within the index)
Colin Beveridge
Chief Investment Officer
True Potential Investments
Please be aware that this communication should not be considered as financial advice.
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