By now, most people are aware that our world – especially the situation with COVID-19 pandemic – is changing and developing lightning fast.
For example, the opening line of my last week’s canny view column was, “On 12th August the 52nd Parliament dissolves in New Zealand, and the 2020 General Election will be held on Saturday 19th September.”
The first half of that statement is not correct anymore.
A COVID-19 outbreak in Auckland on 11th August has forced the government to postpone the dissolution of parliament as the country’s alert levels changed at noon on 12th August. The very next morning, New Zealand share market dropped by 2.4 per cent in the opening minutes and after 20 minutes of trading, the S&P/NZX 50 Index was down 304 points.
As the virus drags on in offshore markets, it’s hard to find an investor who hadn’t already assumed some form of the second wave of COVID-19 in New Zealand.
Part of the problem surrounds defining what a second wave involves – whether it’s large enough to see mass lockdowns once again or whether it just means ebbs and flows in infection rates and the periodic isolation of specific areas and regions.
If we learned anything from witnessing a steep dive in share prices in March followed by the rebound, it is that no one can reliably predict what is going to happen in markets.
But to have successful long-term investment experience, it is essential every investor understands what the journey ahead would look and feel like.
If you ask a Hawkes Bay farmer about average rainfall figures, he or she is likely to look at you sceptically. Knowing how actual rainfall varies from year to year, farmers carefully manage their crops and irrigation. It’s a lesson many investors could learn as well.
Since the S&P 500 officially became constituted of 500 stocks in 1957, it’s average annual return has been a little over 8%. During those 63 years, the index has returned between 7% and 9% on only four occasions. It has more commonly produced a return of between 19% and 21%, which has happened five times.
What characterises the stock market is unpredictability. It is perfectly ‘normal’ for the stock market to react to the news we have never experienced before and is largely unexpected.
Ironically, this unpredictability is cause for optimism rather than fear. It is the risk any investor must take when investing in stocks. But it is a risk that has consistently been rewarded.
As Elroy Dimson, Professor of Finance at Cambridge Judge Business School points out, the stock market has persistently outperformed bonds and cash in countries all over the world over more than 100 years.
Is volatility a time to pick stocks?
Each day there are almost $700 Billion of stock trades across the world. Without doubt, a lot of information and expectations about the future are being factored into the prices in those trades. Remember – for every seller there must be a buyer.
Most explanations of recent market behaviour reflect hindsight bias detailing what everyone now knows. It is rare to hear someone asked a question about a market move and not give a detailed after-the-fact explanation. Few are willing to admit that they really don’t know or that many market moves are simply random.
It is also common to hear a stockbroker say a stock-picking approach is best adopted when markets are emerging from a stressed environment, as it’s easier to pick the undervalued stocks. Their value proposition is to make 12-month forecasts and then trade clients into the next ‘big thing’. There are many research papers that refute this approach, but my favourite is by Matt Walcoff and Lynn Thomasson.
Working for Bloomberg, they analysed all U.S broker recommendations for stocks included in the S&P 500 Index for the period March 2009 (which was the low point for markets during the GFC) to January 2011. The report found:
STOCKS WITH THE MOST BROKER BUY RECOMMENDATIONS ROSE BY 73% ON AVERAGE DURING THE PERIOD
S&P 500 INDEX ROSE BY 88% DURING THE PERIOD
STOCKS WITH THE FEWEST BROKER BUY RECOMMENDATIONS ROSE BY 165% ON AVERAGE DURING THE PERIOD
Result: An investor would have made 53% more in returns by buying the stocks the brokers said to stay away from.
Conclusion: While some investors might find it easy to stay the course in years with above-average returns, periods of disappointing results may test an investor’s faith in markets. But with a good financial adviser by your side, who ensures every decision you make is aligned with what is most important to you and your long-term goals, can ultimately endure the ups and downs in the market.
The article is prepared in association with Stewart Partners, Australia. The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz
