11th Aug 2022 by Tor Flonaes

Disciplined long term investors should expect antigravity - if the past is prologue

Investment timing

What should investors do if they believe there is some irrationality in the markets? How can they take advantage of it? 

Whilst it is generally true that ‘what goes up must come down’ in the physical world, financial markets can differ and ‘what goes down usually comes up’ may be more appropriate. Markets are, in a way, capable of antigravity in the long term and much more likely to set new highs than return to previous lows.

Here are a few powerful charts to illustrate the point.

It is hard to argue with the chart of long-term market trends (upward).

Looking at intra year volatility vs final outcome for the year (despite volatility, most years end positively):

Source: Dimensional

And this one shows the magnitude and duration of bull markets vs bear markets (bet on the bull in this fight):

Source: Dimensional 

Despite the evidence above and the fact that US equities beat T-Bills (short term US interest rates) 70% of all one year periods (Between July 1926 and December 2021, Source 1 see below), it is fascinating to observe that most investors on average do not tend to expect positive returns from equities over the next twelve months:

This is why we often hear market commentators say that “Markets climb a wall of worry”

Source: New York Fed Survey of Consumer Expectations

So why are people so pessimistic? 

A lot of research into behavioural finance has been conducted some of which has been awarded Nobel prizes.  I am sympathetic with the view that investors are not always rational, but it is extremely difficult to take advantage of these irrationalities. Sometimes the market becomes too optimistic and sometimes it becomes too pessimistic, both can be irrational for longer than one might expect but it is ultimately down to fear and greed.  Recently we saw sky high valuations in certain companies and securities.  We have witnessed extraordinary falls for some of the popular investments of recent years.  Below is the performance of the so called “Meme” stocks (stocks promoted in social media), ARK Innovation fund (Cathie Woods’ fund focusing on high growth tech stocks) and Bitcoin since November ’21:

So what should investors do if they believe there is some irrationality in the markets? How can they take advantage of it? 

As mentioned, it is extremely difficult to take advantage of it because it means going against our animal instincts.  Laymen and professionals alike get seduced by the emotions of fear and greed.  As a result, being patient and sticking to a sound long term investment philosophy, not get seduced into concentrated bets by excessive returns in certain investments or shaken off track by periodical volatility stands a better chance of meeting investment goals.

What is so fascinating to me is that whilst this theory is fairly straight forward, the execution of it is extremely hard precisely because of our ‘animal spirits’ and those powerful emotions- fear and greed.  These emotions can overpower the rational side of our brain exactly at those times when discipline is required.  I believe that most investors underperform markets over time because they fail to stick with the plan and keep a long-term perspective, in particular at times of extreme volatility.

“Mo money, mo problems!”

Ultimately we want to avoid getting more worried as we get wealthier, which may be rational from the perspective that we have more to lose but is clearly irrational from the perspective that now we have a larger buffer. 

To conclude, I believe the intersection between return on investments and life enhancement is slightly different for all of us.  Our job as wealth managers is to help our clients meet their financial goals so that they can enjoy the journey as much as possible, which I believe ultimately comes down to helping our clients have a deep-rooted faith in their plan and our advice.

The Legal Stuff

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