01 Mar Dictators might win in the short term, but in the long term, democracy usually prevails
Hardly a snappy title, nor is it my own, as it was blatantly plagiarised from Timothy Garton-Ash Professor of European Studies at Oxford University. Whether we believe this to be true is a matter of personal perspective but it does set an important context for where we find ourselves as investors right now.
In our previous update a week or so ago, we said we would continue to communicate if the tension in the Ukraine intensified, was likely to be protracted or had a continuing (negative) influence on the investment world. No doubt it has intensified, it does have the potential to be drawn out and is certainly causing markets to be fractious.
Wealth Managers are not politicians and we are certainly not military strategists and this makes second-guessing what happens next extremely difficult. There will be a number of questions the investment community will be asking such as how quickly will sanctions be felt, will Ukraine resistance lead to a drawn out conflict, will Putin overplay his hand by venturing into NATO territory, to name but a few.
But even if we could predict with reasonable confidence how the conflict might play out, assessing the market reaction is perhaps even harder to quantify. So whilst it might sound trite, the best advice is often to stay put, ride out the volatility and wait for a recovery, which is usually quite rapid, as we witnessed with COVID.
The chart below highlights this point perfectly. It shows the S&P500 performance since the global financial crisis. You will see during the period under observation that markets have had to contend with some fairly significant inflection points. There is always something for investors to worry about, but over time, this does not derail stock markets for long.
In fact, investing on the eve of the global financial crisis, investors will have experienced losses of almost 50% immediately afterwards, but still went on to secure an annualised 11% return over the following decade or so. There are a number of reasons that account for this. The most obvious is that in the short term, investors by and large, are irrational and tend to act on impulse. They buy more when prices are rising, and panic into selling when things go into reverse. This temptation should be resisted at all costs.
We have said many times before that markets, over time, are driven by earnings. What we mean by this is that by investing in good quality companies which increase profits year on year, and reward shareholders with higher dividends, share prices will rise. The notable feature of company earnings is that over the long term, they are generally pretty stable. True, during COVID earnings took a beating, but this is very unusual and they recovered quickly. Over the long term, earnings tend not to display much volatility, yet stock prices often do, and this creates opportunities for investors.
On 24th Feb the FTSE 100 fell almost 4%, the worst trading day since the early stages of COVID. We used this weakness to rebalance portfolios to take advantage of these extremes. The following day the UK market rose by a similar amount, one of the sharpest turnarounds in history. In two trading sessions last week the S&P500 rose almost 7%. This is about as volatile as things get and if this persists, we will rebalance again. And again.
In the meantime, the question investors should probably ask themselves is whether Russia invading Ukraine fundamentally undermines the ability of companies in the major developed economies to eke out profits. Given the Russian economy accounts for about 1.8% of world output, and Ukraine significantly less, the answer to this is in our opinion is probably not.
Just as democracy wins out over the longer term, so too do corporate earnings.
Dr Andrew Mann
Investment Director