Over the years, I have written extensively about the need for successful investors to come to terms with uncertainty. Most recently, our guest contributor Dr Steve Garth wrote about the difficulty of predicting what markets might do in the next twelve months given the circumstances of the current inflation problem. An unusual cocktail of Covid stimulus, high energy prices caused by the war in Ukraine, and post-Covid supply chain constraints, have come together to drive inflation to levels we have not seen since the early 1990s.
Central governments intent on taming inflation are raising interest rates so rapidly that bond markets, caught unawares, are reacting with bond market selloffs, while stock markets, fearful of economic slowdown and recession, are also under selling pressure.
We have not seen all market indices in negative territory since the recession in the early 1990s. That too was a challenging period.
Since the third of January 2022, the US broad share market indicator, the S&P500 index, has fallen by 23.96%, while the Australian equivalent, the ASX/S&P200 index, has fallen by 15.08%. One of the reasons the Australian market has done so much better than the US is that we have a relatively low exposure to technology and other high-growth stocks.
Broadly speaking, our client portfolios have weathered this current storm better than most, with our strategic exposure to value stocks providing a performance lift that has cushioned other asset classes. This strategy is intentional. We know that when markets are hot, the growth companies do best. We intentionally ‘miss out’ on some of this market froth because we have a value allocation. We know that when the market turns and growth stocks fall from favour, the value stocks tend to perform far better. This shouldn’t be a surprise because value stocks are underpinned by strong operations and dividend flows.
There’s a strong analogy between financial markets and stormy weather. Financial markets are unpredictable, volatile and challenging, just like the oceans in a storm. When we set sail for a voyage in fair weather conditions, we would never do so without making appropriate preparations for the inevitable storm. Life vests – check. Life raft – check. Emergency locator device – check. And so the list goes.
The checklist isn’t so tangible for financial markets, but it comprises a range of emotions and responses we are likely to encounter on our investing journey.
Checking the ‘investment life raft’ is also an interesting exercise.
To make this point, I have taken data from the last time we had global inflation driven by energy price shocks. The period was known as the Oil Crisis. To illustrate the period, I used an aggressive portfolio of 50% US and 50% international shares. For the purpose of this exercise, I am assuming we had $1,000,000 invested just before the onset of the crisis.From November 1973 to September 1974, the world’s share markets fell heavily, and our portfolio fell by 37.89%. Now, this portfolio is far more aggressive than almost any of our clients would ever have, but all the same, even more conservative portfolios were feeling this fall. Our $1,000,000 portfolio was valued at $621,097 – on paper, a loss of $378,903.
From the start of the crisis to the market hitting rock bottom, took 11 months – long enough for any investor to feel twitchy and anxious. Like today, the news cycle was in overdrive reinforcing the dire state of the world.
What we do next as investors seals our outcome. A decision to sell locks in the certainty of a loss – converting it from paper to reality. Then comes a complex set of decisions about what to do next. See safe harbour in cash or find a way back into markets when the storm abates.What happens in the years post-crisis is instructive. Let’s assume that despite our deep instinct to do something to ‘save’ our portfolio, we stick out the storm and wait for the recovery. Over the next nine months, the portfolio recovered its full value to return to its pre-crisis value of $1,000,000. From start to finish, the whole episode took an uncomfortable 20 months.
Five years after the start of the oil crisis, the portfolio $1,000,000 portfolio was worth $1,372,000, and ten years on, the portfolio was valued at $1,859,600.
Any investment in markets required a long-term commitment and this lifeboat exercise provides a clear, real-world example of how an investor is rewarded for discipline and patience. We understand that it’s tough out there at the moment, but as always, we urge calm. How you respond to this storm will determine your outcome, and we are here to help you stay safe.