25 Mar Attempting to time markets can seriously damage your wealth
Welcome to the latest of our weekly bulletins. I was speaking to one of my relatives in Ireland over the weekend and he quipped that the UK authorities were fighting two battles – COVID19 and stupidity. As it turns out, queues forming at seaside fish and chip takeaways at the weekend has brought about the inevitable lockdown.
In this edition, we provide an update on how CDC is adapting to the latest guidance, and consider the impact the latest measures might have on financial markets.
An update to CDC’s operating model
In last week’s update we advised that CDC’s head office would be manned on a rotational basis and that most staff would revert to working from home. Given the more stringent guidance announced on Tuesday, we have decided that except in absolutely exceptional circumstances, CDC will now move to a fully remote operating model, until further notice.
Whilst this is extreme, we are sure our customers will fully understand our desire to follow the guidance and to make sure our staff remain safe and well. The team at CDC is in daily contact with each other and we know this model has been tested, and allows us to deliver ‘business as usual’.
These days, we very rarely receive physical post from customers, but for now we would ask that all correspondence with your adviser or their assistant, is via the telephone or email.
We will of course keep this under review and communicate updates as the guidance evolves.
Market update
Financial markets have continued to whip-saw as investor mood oscillates between pessimism and brief bouts of optimism. Whilst it is a well-worn phrase within the investment community, successful investment truly is ‘about time, not timing’.
Put simply, the central thesis here is that nobody, however smart they are, can consistently time their entry into and out of financial markets with precision so investors are best served by staying fully invested and riding out the peaks and troughs and by doing so, they will be rewarded over time. I see this as analogous with the children’s fable of the hare and the tortoise. Moreover, with investments, as we highlight below, timing is fraught with danger, and as such can seriously impede returns.
But before we delve into this, the more pressing question many investors might be asking themselves, is when markets might stabilise. The chart below relates to the impact on US stocks over key stress events (1929, 1987 and 2008):
Whilst the chart is a few days old now and the black line has fallen further, you will see during the first few trading days of the most recent crisis, share prices followed a very similar pattern to those of past events. Experience suggests the first 10-20 trading days tend to be marked with high levels of volatility but eventually this evens out and usually by day 49, things tend to look a bit calmer.
There are a number of reasons why we cannot be certain this precise pattern will be repeated but it is worth noting this is the first major shock where social media has played a big part in consumer and firm behaviour so we cannot be sure if this will elongate or truncate the volatility. It has certainly contributed to the fact that this has been the steepest decline, and this is hardly surprising given the duality of the virus and the collapse in the oil price hitting markets simultaneously.
At this point it is worth pointing out that the suspension of property funds, which has affected M&G for a number of weeks now, has spread, and most mainstream funds are now temporarily ‘gated’, including the Janus Henderson fund we use at CDC. Gating means investors cannot withdraw or add to their property funds on a temporary basis. This has happened before (after the Brexit referendum) and should not be a cause for concern. In fact, following the suspension in 2016, property as an asset class recovered well, returning almost 13% over 2017 and 2018. The 20 year average return has been 7.5%. The issue with property funds is they are priced and tradable daily, but their underlying assets (commercial properties) are inherently illiquid. This means in times of stress, the managers sometimes need to sell underlying properties to meet withdrawals, and this takes time. Suspension, provides the ‘time-out’ necessary to do this. We are in regular contact with both M&G and Janus and will keep investors updated.
Whilst social distancing is necessary to contain the spread of infection, it has pretty grave consequences for consumer demand and will certainly translate into some dire economic numbers later in the year. This will have inevitable consequences for company earnings around the globe, but it is worth remembering we have seen this kind of thing before. As the chart below shows, an economic shock leads to company earnings (as measured by earnings per share, or EPS) falling, but they do rebound, and very often quite quickly. Interestingly the flu pandemic of 1918 led to the shortest recession on record (7 months):
This leads us back to the central tenet of this update. During the darkest times many investors, even those with experience, panic and capitulate whereas all the evidence points to the fact they should resist this urge. Markets rise and they fall, but some of the best trading days actually follow some of the worst and this makes being invested for the best, and sitting on the sidelines for the worst, pure folly. The chart below which I have shamelessly plagiarised from Fidelity helps to illustrate the point:
As you will see, by remaining fully invested in US equities from 1980 for 40 calendar years, an initial investment of $10,000 would have ballooned to $659,000 but missing just 5 of the best trading days reduces that return by 35%. Missing the best 30 days (and this is over 40 years remember) reduces the return by 81%. It is ultimately the economy and company earnings that drive share prices higher over the long term, so if company earnings dip, and then subsequently recover, why shouldn’t share prices ?
One way we measure value in equites is through the PE ratio which means price:earnings. Very simply you divide the current share price by the earnings per share of a company (or the market average). So if the market sits on a PE ratio of 10, it means it will take 10 years of earnings to recoup the price you paid for your shares. Generally the lower the better. Pre-crisis we were concerned about US valuations on a PE of 27, it is now on a much more affordable 15. The FTSE100 in the UK is 11 and we are seeing some domestically oriented companies trading on as little as 2.5 times earnings. That is bargain territory that will not last forever.
Before signing off, it is probably worth a quick word about China where this all started. The purchasing managers (PMI) data measures manufacturing activity. A score above 50 denotes expansion, below 50 is contraction. The latest Chinese reading was 28, a pretty grim number. But at the risk of calling a false dawn, following the lockdown, things do look to be returning to some normality. Workers are back at work, coal use is almost back to pre-crisis levels, traffic figures are higher and travel restrictions have been relaxed.
This has fuelled a strong recovery in share prices there, as the chart above shows. Just one word of caution; the world will be watching now restrictions are being relaxed. Clearly a new spike in infection rates would bring a fresh wave of volatility. Italy, Spain, UK and the US are some weeks behind but our sense is once infection rates start to moderate, which they will, we will witness a similar snap-back in prices. Further evidence if any were needed that investors should sit tight.
We will write again next week.
Dr Andrew Mann
Investment Director