Sunday, May 03, 2020, The Sunday Times
The Perfect Time to take Advantage of Troubled Markets
Market setbacks are painful for those already invested and offer opportunity for those who may have spare resources. The No 1 question that investment advisers probably get asked is: when is the right time?
As we can’t tell the future, few of us know. There are some familiar signs of market tops and bottoms, but they’re never precise or consistent enough to be reliable.
I’ve previously highlighted “capitulation” as an excellent timing indicator of market bottoms. There are rare occasions, never comfortable ones, when there is a complete absence of buyers for whatever reason. This time around it was the sudden realisation of a global economic lockdown and the likely impact on business.
However, due to the liquidity in markets, sellers persist until buyers emerge, at which time in all likelihood you have the bottom, or soon afterwards. Capitulation is a measurable event.
I say “in all likelihood” because, of the 17 capitulations events that have occurred in US equity markets since 1953, markets recovered 26% on average the following year, with just one instance of a loss after 12 months.
Nothing is guaranteed in markets, as we know, but I’d prefer to be armed with those objective facts. If the sellers have sold what they were trying to sell, then it makes sense that the bottom is probably in. It’s the reason why markets can discount bad news much quicker than most think possible.
I’ve always been struck by the great wisdom of Ben Graham, author of The Intelligent Investor, in which he said: “An investor can take advantage of the wide and recurring fluctuations in stock prices by way of timing or by way of pricing.”
By timing, Graham meant trying to time your entry into and exit from markets. Of course, everyone would like to be out of bear markets and in only for the uptrends. Graham always argued that trying to time markets like that was speculation, not investment.
By pricing, Graham is referring to the fact that you can price an asset and, if it offers the prospect of a reasonable return with minimal risks, then you can make an informed investment decision. This approach keeps you in markets, but in specific investments that fulfil those criteria.
The latter approach has the advantage of not needing to time markets, which actually eliminates the risk that you will be left out of markets when they rally. As markets make upward progress in the long term, that’s a principal risk.
And while the value of your investments goes down with markets, that’s not the same as suffering permanent losses. When markets recover, as they inevitably do, and assuming your investments are sound, they should also recover in value and grow to reflect the growth in earnings at the companies.
It has always struck me that this approach is the only true way to invest. Volatility is a fact of life in markets and can’t be willed away.
Since the global financial crisis, and with some amendments to regulations, the investment community has tried to dampen volatility for retail clients with the introduction of absolute return funds. They promise positive returns without much volatility.
Our own research has shown that such funds add no value over and above a traditional lower cost, and probably lower risk, mixed asset portfolio made up of equities, for higher returns, and cash and bonds, to cover all the big economic risks.
What an investor really needs is a plan to navigate all market conditions. The regular investor, and that includes someone saving via a pension fund, should be loving these battered markets. Additional savings can be put to work at much improved values.
Lump-sum investors, the people who are unlikely to be in a position to add further to their savings programmes, have the trickier task. The solution is to first make sure that you have time, and a five-year commitment carries high odds of success.
With time on your side, you can simply invest the lump sum now provided you feel you are obtaining sufficient value to underpin reasonable returns on a five-year view — the Ben Graham approach. Or you can average in over time.
Should you decide to average in over some timeline, you should put objective rules in place at the outset. Commit to averaging in at set intervals, or speed up the commitments if markets decline further.
This plan avoids the scenario where you are waiting for market setbacks, but they keep rallying higher.
Rory Gillen is the founder of the investment advisory firm GillenMarkets