All things being equal, the finance industry's chief task is to foster confidence so, as London-based economist Andrew Smithers has observed, as far as the finance industry is concerned, "all news is good news".
That's not to say that advice about not panicking is generally good advice — retail investors apparently have a long history of throwing in the towel at the bottom and then buying at the top so gritting your teeth and hanging in there is usually the right thing to do.
It may be, however, that retail investors' tendency to call it quits at the first sign of trouble relates more to the fact that they didn't get the full picture to start with and, frequently, their risk profile was mis-specified because the industry standard high level of fees cannot tolerate too many genuinely low risk assets in a portfolio.
For example, buying more shares after a downturn or hanging in there is not always the right thing to do. On the 20 Oct 1987, the NZ stockmarket dropped by 16%. The day after that, Dodgy Tuesday following the US crash of Black Monday, I vividly remember the phones going crazy as everyone bought stocks at "bargain" prices. But barely ten days later, the NZ stockmarket had fallen by a further 26%. About a year later, prices had fallen by 57% from the "bargain" level they were at the end of the day on Dodgy Tuesday. The 1987-1991 period taught many investors that buying the dips wasn't always a good strategy, which brings to mind the old market adage that investors shouldn't panic but if they are going to panic, they should panic before everyone else does.
Let's examine the "markets have fallen therefore things are cheap" conclusion first.
This analysis implicitly assumes that "I am sensible" and "the people who pushed the market down and sold are stupid". This might be valid for markets dominated by retail investors and leverage like China, but it's a long draw of the bow to say that just because Apple's share price is down 20%, it is now 20% cheaper. That might be correct, but it equally might be incorrect. It's more likely that the army of analysts who spend all day, every day discerning Apple's future have determined that its profits, because of a weaker China etc, will be 20% lower. Therefore, far from Apple's shares being cheaper, their share price merely reflects their diminished fortunes. One has to be modest in this business. Warren Buffett can afford to back his judgments 100%, but KiwiSaver investors need to acknowledge uncertainty and hedge their bets. Recall all the local experts who for the last ten years or so have said interest rates were too low and must rise. Goodness knows how much that bad advice has cost their clients.
Now let's look at the "time in the market is more important than timing" myth.
We first explored this piece of dubious advice back in 2005 when we looked at Cliff Asness' article in the Financial Analysts Journal entitled "Rubble Logic". Asness is the Principal of hedge fund AQR Capital. He has a PhD in finance from Chicago and has previously lectured at Yale and MIT. The "time in the market" fable is convenient to the finance industry because it tells Mum and Dad to leave their money where it is, continue paying fees and things will get better. This isn't always the case, at least not given the limited horizon of many retired investors.
Asness says "consider the hallowed property of equity returns that stocks never lose if held for the long term. Well, if a decade is your idea of the long term, then this is only true when prices start out cheap. When they start out expensive there are decades where stocks not only lost to inflation but lost big".
Asness has produced a table which shows that on average if you buy US stocks when their 10 year average price earnings multiple is in the 20-30 range the average return in the following 10 years is negative after inflation. Mr Asness concludes that "a long term investor should seriously consider their entry price".
In other words, timing is important. We have looked at this topic more recently when we examined an addition of the Global Investment Returns Yearbook (GIRY). In the 2013 version of the GIRY, the London Business School professors also demolished the time in the market nonsense when they showed that investors in a number of stock markets had to wait a very long time to achieve a return in excess of inflation. Their statistics show that since 1900 the longest time it took the NZ stock market to get back to the same value adjusted for inflation was 22 years, US investors had slightly less time to wait at 16 years, but if you had the misfortune to invest in the Austrian stockmarket, just prior to WWI you would have had to suffer 97 years of losses before you broke even. Aberration, you think? Unfortunately not; the numbers for France, Italy, Belgium, Japan, Spain and Germany are all more than 50 years. Obviously, these numbers are impacted by the WWII, but the fact is that the future is unpredictable and bad things do happen.
The finance sector has a long history of distorting information for its own purposes including downplaying the importance of fees, overstating forecast returns and understating risk. Confidence is hard won, easily lost. The industry and its acolytes in government need to consider whether, in the long run, telling it like it is might be a more profitable strategy.
As legendary American actor, Will Rogers, once said "it's not what we don't know that hurts, it's what we know that ain't so".
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent may have an interest in the companies discussed.
