Market volatility, capital preservation and my holidays
I’m beginning to think that my holidays are turning into a reliable market indicator. Short-haul, good; long-haul, reach for your hard hat. Three years ago, when we visited Japan, the market took a dim view of renminbi weakness and shares fell for another six months until bottoming in early 2016. This year’s empty-nester jaunt to Hawaii with Mrs S, from which I’ve just returned, also ended badly from an investment perspective. I think Europe beckons next year.
I love Americans’ attitude to the stock market. Ask most people here what they think of the stock market and, if they have a view at all, it will most likely be negative. While I was away, I had conversations with a builder from San Francisco, a young man behind a till in Brooklyn and a former backing singer for Cliff Richard about where they are currently invested. They all understood the link between the market and their financial security. And they knew who was responsible for it.
But back to the recent market volatility. I was speaking on Friday to a jittery audience at the London Investor Show. My topic was growth, income and capital preservation. I had hoped to focus on the first two but inevitably the main interest was in the last of these three pillars of investment. It is, of course, the most important because if you don’t hang onto your capital, you can forget about the other two. As Warren Buffett says, rule number one: don’t lose money, rule number two: don’t forget rule number one.
Capital preservation is particularly important at my time of life, which is why I’m so interested in how to navigate periods like the one we are going through at the moment. Having experienced something very similar in February, we are at least getting some practice this year, as I feared we might.
I think I may have shocked some of my, let’s be honest slightly more mature, audience last week with a chart that vividly illustrates Buffett’s advice. It shows the post-retirement experience of two investors, both of whom start with the same amount of money, both of whom take out the same regular income and both of whom experience the same investment returns over a 30-year period.
The difference between the two is that one has the other’s investment returns in reverse. Rather than the actual returns from 1980 to 2010 (20 good years and 10 volatile and generally bad ones) the second retiree has ten bad years and then 20 good ones. Unfortunately, because he or she is taking money out to live on while the market is falling, the 30-year period ends after just 22 years when the money runs out. Rule number three: if you are going to lose money, leave it as late as possible.
There is no particular rocket science about my formula for not losing money. But simple tends to be good when it comes to investing so it bears repetition. First, accept that the future is unknowable and diversify accordingly. In the 20 years that I have been tracking this, the best-performing asset class or geographical region has never been the same as in the prior year and the ranking has been wholly unpredictable. The only way round this is to put your eggs in as many baskets as possible. And to be grateful that in none of those 20 years have all the assets fallen in tandem. Diversification really does work.
The second mantra when it comes to capital preservation is to pay careful attention to valuation. The most important determinant of your long-term return from any investment is the price you pay at the outset. Buying when markets are expensive stacks the odds against you generating a good enough return to offset the withdrawals from your retirement fund. Or to deliver the growth you need if you are still accumulating. In fact, there’s plenty of evidence to show that there is a straight-line inverse correlation between the price you pay and the returns you will achieve on average.
Which brings me back to today’s market. Just like in February, stock markets around the world have lost perhaps a tenth of their value in short order. It has been a bruising experience. One fund manager I had lunch with last week said he hadn’t felt this way since 2008. We’ve all been reminded how much more tempting it is to check the value of our portfolios on the way up than when they are falling.
But what this global equity fund investor went on to say was also interesting. He said he is finding more great investment opportunities than ever before. To the extent that he can, with an almost fully invested fund, he is looking to get back into the market as quickly as he is able.
I think that’s right. The correction we have just experienced feels quite technical, driven by automated trades that (stupidly in my view) manage risk by reducing exposure to a falling market. It has also been almost totally undiscerning. Basically, everything that has gone up a lot this year was clobbered. No surprise, for example, that when Adobe unveiled good figures last week, its battered shares immediately bounced back as investors realised they had thrown the baby out with the bathwater.
It’s also becoming clear that markets are diverging this year. The FTSE 100 and most European markets are well down over one year while Wall Street remains in positive territory. Japanese shares are perhaps a third cheaper than they were at the start of the year as earnings have continued to rise as the market has fallen. The Chinese market is starting to look interesting after a calamitous few months.
The final piece of good news is that I have no holiday plans.
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