I’ve spent this week seeing investors and their advisors. I always enjoy being on the road talking to people about investments, as it helps me gauge broader investor sentiment.
With world markets ending the year well (as we had expected), it remains somewhat stunning just how disbelieving most people are about the strength of global equity markets.
While I believe this has been a classic example of “bull markets climbing the wall of worry”/“don’t fight the Fed”, there should be no doubt this has been the least euphoric rally I can remember in my 25 years in equity markets, probably because most people have been too defensively positioned.
My general view is nowadays investors simply have an unprecedented amount of short-term “noise” to navigate through. That short-term “noise” is highly distracting, usually bearish, and, if acted on, unlikely to lead to investors getting the maximum reward available from their equity investments.
Equities are volatile in the short term — that’s the nature of the beast. This is particularly so with high frequency trading dominating the daily equity liquidity picture. There are even algorithms that trade off Twitter headlines!!!
However, over the medium to longer-term, the attraction of equities is the compound total returns available. You will only feel the effect of the compounding process if you invest for the medium to longer-term and resist the temptation to “sell” on every scary Twitter headline.
In 2019, there have been numerous occasions when short-term volatility could easily have tempted investors to press the “sell” button. Judging by my conversations with investors, many did, particularly in August at the peak of “trade war” rhetoric.
There are very few great short-term traders in the world because successful short-term trading is counterintuitive to the basic make up of average human psychology. Great traders sell into euphoria and buy into panic. That requires a different internal setting that most individuals have available.
What all of us need to accept is that it is highly unlikely we are a “great trader”. Once we accept this, as I have many years ago, you can focus on being an “investor”. An investor’s friend is time, duration, conviction and fundamental company research.
What I am going to do below is demonstrate the importance of not attempting to “time the market” over the medium term. If you get the “timing” wrong, as most people will, it will seriously affect the returns from your equity portfolio.
The chart below shows the MSCI World Net Total Return Index (USD) over the last 15 years (dark blue line) and the compound average growth rate it delivered of 7.1% p.a.
Now we are going to explore what effect being “out of the market” on the “best” index return days had on annual returns.
The red line shows the return generated if you exclude the “best 5”index return days in the last 15 years.
The grey line shows the return generated if you exclude the “best 10” index return days in the last 15 years.
The light blue line shows the return generated if you exclude the “best 20” index return days in the last 15 years.
The green line shows the return generated if you exclude the “best 30” index return days in the last 15 years.
The purple line is OECD G7 inflation.
You can see in the table below it, the dramatic reduction in the annual return that “missing” even a small number of “best” index return days generates.
If you missed just the 5 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 4.8%.
If you missed just the 10 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 3.1%.
If you missed just the 20 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 0.8%, or less than inflation at 1.7%, a negative real return.
If you missed just the 30 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to -1.1%, negative absolute and real returns.
Yes, historic performance isn’t a guide to future performance, however, the evidence above clearly reminds you of the importance of being invested on the major index up days. If you miss the major index up days, you will miss the compounding effect of being invested in equities as an asset class. It’s that simple.
Historically, many of those major index up days have come after periods of index weakness, volatility and uncertainty. These periods most likely saw investors “sell” equities because of the prevailing negative headlines.
2019 has been exactly the same and started from a very low point after the December market falls in 2018. But it wasn’t just the recovery from the 2018 lows, even the last six months have been volatile.
The chart below is of the S&P500 over the last six months. It confirms that the return from the mid-August lows alone is now greater than +10%. That is akin to missing out on more than the annual average compound return from global equities over the last 15 years, in just four months.
I realise it’s an over-used cliché but it’s right. Successful equity market investing is about time in the market not timing the market.
What I’ve done in 2019 is cut out all unnecessary noise out of my investment process. This is to the displeasure of the stockbroking community and to the benefit of my investors.
When you remove yourself from the noise and focus on long-term fundamental investing in the best businesses in the world, you will be positively surprised by the results compounding delivers over time.
Stay the course, it’s a long game…
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.