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STOP THE PRESS STOP THE STRESS

Is it time to “Sell everything except high quality bonds”? Economists at the Royal Bank Of Scotland, the state owned bank, released a sensational research report last Tuesday which has gone viral, telling clients to sell all their assets and buy high quality bonds 1.  We received questions all week from clients, friends and families from across the world asking what to do in light of this report and the difficult start to the year for equities, commodities and all risk assets.

 

Our opinion of the RBS research report is simple… It is not grounded on any verifiable research or data that is known to accurately predict future stock market performance and as such should be summarily disregarded.  It is simply a sensational research report that may prove to be right, but it is highly unlikely that it will.  It is possible that equities may fall substantially this year and we should expect a market correction every once in a while.  In fact historical data established that a market correction of 20% or more occurs on average every 3.5 years in the US and the recent 5% loss there happens on average every 71 trading days or so 2.  So what we are experiencing now is normal stock market activity and would be anticipated by experienced investors.  The stock market does not always appreciate, but it often does (historically more than 70% of the time).

Denise

S&P500 Performance Annually 3

Also the US stock market has been five time more likely to be up 20% or more any given year the down 20% or more 4 .

In true market fashion, risk perception has dramatically swung from optimism in May 2015 to current pessimism as investors are starting to fear a ‘cataclysmic’year and consequently, have been selling equities over the past two weeks5.  Readers of our blogs and long time clients will be familiar with “our friend” the manic-depressive Mr. Market6 who’s mood wildly swings back and forth from optimism to pessimism and who offers the “astute”… investor investment opportunities to buy low and sell high.  Benjamin Graham (the creator of Mr. Market) told us to ignore Mr. Market and to focus on the intrinsic value of stocks.  He believed that investors should buy stocks when they are depressed or inexpensive which he called ‘value’ stocks.  Eugene Fama the 2013 Nobel Laureate in Economics and Kenneth French showed in their research that both value and small company stocks tend to outperform the stock market 7 and Fama showed that astute investors should not try and guess the direction of markets in the short term 8.

Investor behaviour is crucial when it comes to successful investing.  Dalbar produces an annual report called the Quantitative Analysis of Investor Behaviour.  This has been one of the industry’s best and longest running reports on how poor individual investors perform because of simple investing mistakes that they continuously repeat.  There are 9 distinct investor behaviours that they report lead to this underperformance – one of which is ‘Media Response 9’.  The 2015 Dalbar study showed the average US equity mutual fund investors underperformed the S&P500 by 8.19% in 2014 (5.50% vs the index at 13.69%) and the average fixed income mutual fund investor underperformed the Barclays Aggregate Bond Index by 4.81% in 2014 (1.16% vs the index at 5.97%).  Over the past 20 years the gap was 4.66% per annum for US equity mutual fund investors.  So on that basis, for $100,000 invested  in the S&P500 the investment would be worth c$654,638 as opposed to $275,099 10 (that’s almost 2.5 times as much).

 

 

Denise

 

 

Another (older) study published by Terrence Odean in the Journal of Finance supports the Dalbar results and is titled ‘Trading is Hazardous to Your Wealth’11.  Ironically he quotes Benjamin Graham on the very first page who squarely points the blame at the investor himself – ‘The investor’s chief problem—and even his worst enemy—is likely to be himself’.

 

So our strategy is simple:

  • Diversify – Diversify investments in stocks, bonds and other investment. Some investments will have good years while others are having bad years.
  • Rebalance periodically – Sell some stocks when they become too high a percentage of a portfolio and buy stocks when they become too low a percentage of a portfolio.
  • Control behavior – Don’t panic when the market falls as this is normal market behavior.
  • Don’t trade too often and stick to a buy and hold strategy.
  • Don’t pay attention to the media or financial ‘experts’ predictions as they get it wrong more often then they get it right. Remember a broken clock is right twice a day.

 

The start of the year has been unsettling to many investors but behavior during times of market stress is crucial.  We hope you found this article helpful and that it puts the recent market activity into perspective.

 

Risk Warnings

The above Blog does not take into account the specific goals or requirements of individuals and is not to be construed as advice. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.

Past performance is not an indicator of future results.

Currency fluctuations may increase or decrease the returns of any investment.

You should remember that the value of an investment and the income from it could go down as well as up.  The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.

[1] RBS research note http://www.theguardian.com/business/2016/jan/12/sell-everything-ahead-of-stock-market-crash-say-rbs-economists

[2] Bloomberg

[3] Standard & Poors

[4] 50 out of 191 times the US stock market has risen more than 20% in a calendar year.  In only 9 out of 191 years it has fallen by 20% or more.

[5] Trimtab ETF flows http://trimtabs.com/data/fund-flows.html

[6] Mr. Market is an allegory created by legendary investor Benjamin Graham and often sited by Warren Buffet https://en.wikipedia.org/wiki/Mr._Market

[7] The Fama French three-factor model https://en.wikipedia.org/wiki/Fama%E2%80%93French_three-factor_model

[8] Efficient Market Hypothesis https://en.wikipedia.org/wiki/Efficient-market_hypothesis

[9] ‘Tendency to react to news without reasonable examination.’

[10] $100,000 compounded at 9.85% annually over twenty vs vs $100,000 compounded at 5.19% annually over twenty years. http://www.qaib.com/public/downloadfile.aspx?filePath=freelook&fileName=fulleditionfreelook.pdf

[11] http://faculty.haas.berkeley.edu/odean/papers%20current%20versions/individual_investor_performance_final.pdf

 


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