Whenever one meets with other investors of late, a question they ask is “”Which way do you think the market is headed?”. One of my sons also asked me that question and I said to him that I had no real clue, although it might continue in the same direction. I give my reasons in this article.
The weekend papers are full of explanations of the recent market declines, and prognostications about the future, by experienced financial journalists. This was no doubt at the behest of their editors who understand that readers are looking for simple answers. When the markets are in rout, the key thoughts of investors are likely to be should I sell, to protect my portfolio value by moving into cash, or should I buy now that shares are becoming cheaper and possible bargains appearing?
Having been through more than one boom and bust in my investing career (chart of the FTSE All-Share in that period above showing percentage change in capital value from 1997), I only make predictions about the market in extremis, i.e. when it looks ridiculously expensive or ridiculously cheap. You can see that so far there has only been a minor correction in the last few weeks. Incidentally that chart shows that the FTSE All-Share is up about 70% in that period while my own portfolio is actually up 270% which I track in a similar way.
Some of the influences that are currently being talked about are the trade wars between the USA and other countries, the impact of Brexit, the ending of QE and higher interest rates, the view that shares had become too expensive, and general despondency. When markets are in decline, all news tends to be treated as bad news. So when the US economy is reported as continuing to grow strongly, this is viewed as negative as it means higher interest rates will come in sooner.
The fact of the matter is that markets are driven by expectations and emotions as much as hard facts. It is undoubtedly true that most investors portfolios are showing very healthy returns in the last few years so everyone is holding on to large profits. That is still true even after the carnage of the last few weeks. But just reading a few tweets issued by investors tells you that many are now showing a loss on the year to date. This makes them nervous.
It’s also true that the long, uninterrupted bull run has pulled many people into stock market investment who think it might be an easy way to make money when cash earns little on deposit and the housing or buy-to-let markets are no longer attractive.
There is one truism though. Once markets start moving in a certain direction, then they tend to continue in the same direction, driven by emotion. Just as share prices of individual companies show high short-term correlation, so do share prices in general. They can both be driven by “momentum” traders now that everyone knows that momentum is a key aspect of successful investment strategies.
Just considering the UK market, where most of my readers are probably invested, it’s also true that UK market trends are dictated by US market trends and other international markets over night. What happens in the morning on trading days in the UK tends to follow what happened in the USA the previous day/night. It’s always worth keeping an eye on the S&P 500 to check that – see this web site for a useful chart of a daily view (or longer periods): https://www.bbc.co.uk/news/topics/c4dldd02yp3t/sp-500
Will that tell you which way the UK market is headed? Only in the sense that trends tend to persist, until they reverse and are driven by international dynamics. Trying to guess which way it’s headed is a waste of time, and effort.
As a result, some folks take the stance that they’ll hold their portfolios unchanged through thick and thin. If you are an institutional investor, where you are paid to invest client’s money in shares, not in cash and your earnings depend on portfolio value commissions, you may not have much choice. But private investors do.
My view is that trying to be contrarian in market declines makes no sense except in extremis. Following the trend is sensible, until there are obvious highs and lows where reversals might take place. So I sell on the way down, and buy on the way up, while trying not to over-trade (i.e. not react to short term moves which tend to be expensive in terms of spreads and broking charges). I also take into account the nature of the stocks and any capital gains tax liabilities that might result, i.e. I will sell those showing a loss or hold those where tax would be incurred. That also means I prefer to sell those in my ISAs and SIPPs where tax consequences can be ignored. The current market is also a good time to rationalise my portfolio which has too many stocks in it and is overdiversified.
In relation to the nature of the stocks, those hardest hit by any general market decline are those that are small and speculative so they are the first to go. In a market rout everyone starts looking at whether the company is making real profits, generating cash and paying dividends in the short term, not to a sunlit horizon in the future.
That’s not to say that I have suddenly fallen out of love with growth stocks. But there is good growth and there are speculations. Companies that have good technology, good business models, and are generating good returns on capital are still the ones I like to own. The recent figures from Amazon and Alphabet (Google) were seen as negative because the growth in sales and profits appeared to be slowing – but they are still growing at a very brisk rate in comparison with old economy stocks. They are both now very big companies so at some point growth was likely to slow, but there are many smaller technology companies who can achieve great growth rates irrespective of the overall state of the economy.
At this point I do not see that we are near a turning point, but neither do I try to predict one. Shares look neither ridiculously expensive or ridiculously cheap unlike say back in 2008 for example when doom and gloom pervaded everywhere. There is no good reason to pile back into bonds with short term interest rates still low and the UK and US economies looking healthy.
To track the trend while managing cash I follow a simple rule – if my overall portfolio falls by £10,000 I sell £10,000 worth of shares and put the resulting cash on deposit. That way assuming you have an unleveraged portfolio you can never go bust. If my portfolio and the market start to rise, I’ll move the cash back into shares.
In summary, I am following market trends and in the meantime am just looking to hold good quality companies and buying more where there are suitable buying opportunities, while disposing of the dogs. I don’t try to bet against market trends.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
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