Market Update + Emerging Themes

One theme emerging from the lock down period is that life and business will be different when we emerge – we will innovate, adjust supply chains and become more adaptable and self-reliant.

The big news this week has been the Job-keeper Allowance announced by the Federal Government, supporting distressed businesses to keep people employed with a support payment. For the recipients it may be considerably less than they’re used to earning but it is something, and the prospect of having a job when this is over is cause for optimism.  While this and other measures may be expensive for the nation; they are necessary to support the economy for the inevitable rebound and rebuild.

1. Update

Markets responded positively to the Government stimulus and while volatility continues, markets are generally stable.  We have had many conversations about portfolio rebalancing in the past two weeks and we have had many people ask; ‘when will be the right time to enter the markets with new money?‘  On the latter point we feel there is still considerable uncertainty, yet the time will come when market valuations will be very attractive.

Question of the Week

“When most commentators are predicting that the market will get worse, why are you not recommending we cash in all investments, and rebuild a portfolio when the market rebounds?”

There are many commentators with many opinions right now and things may well get worse, then again, they may not. This is the uncertainty we are dealing with. The answer to this question lies in a broader discussion of risk, and risk is at the forefront of everyone’s mind. Health risk, employment risk, financial risk, there’s plenty to worry about.

First some important background.

When we build our plan

Investors, by and large, invest in financial markets in the expectation that they will get a higher return than the ‘risk free’ assets of cash and short-term government securities. They do this because it is very difficult to fund their long-term financial needs from cash returns alone. Never has this been more pronounced than in recent times where cash returns are at historic lows.

Between January 1980 and December 2019, the S&P/ASX 200 Index returned 11.25 percent on average per annum including dividends…which most would agree is an attractive return.

During the building of our plan this market-related information is all perfectly logical. When we see the graph that shows the down years we accept these down years as a certainty – there are more up years than down.  That’s the logical part of the planning done.

In the eye of the storm

When the bad times do come our perfectly logical approach to markets is overtaken by a fear response. This too is understandable; it’s called loss aversion and humans are hard wired to avoid loss.

During the GFC we saw the behaviour of non-advised investors in Australian Super do exactly the opposite of what they needed to do. In the graph below we see the almost perfect relationship between of the number of members switching out of growth funds into conservative options, as the markets fell. The further markets fell, the more members switched.

Any plan built on logical evidence-based principles can be undermined by an emotional fear-based response. An important part of our role is in supporting you not to undermine your plan.

In the current market down-turn the same thing is happening with UniSuper reporting that members had switched $2 billion into cash while Australian Super said it was receiving 6,000 calls per day.

So, what’s the problem with selling out and then re-entering the market?

The real challenge lies in the second part of the question – when to re-enter the market.

Every downmarket cycle is volatile, and markets rise and fall sharply due to the release of new information. During any bear market there will be many rallies, any of which could have signalled the ‘bottom’ of the market.

The diagram above shows that there were at least six opportunities for an investor to get back into the market during the GFC – the first three would have been devastating and the turning point the investor had to pick correctly was in March 2009.  This was when fear was at its peak, and it would have taken a very, very brave investor to wade in at this point.

The question we must pose is, what would have the fearful investor become bullish, just when markets are most scary?  Our experience is that this never happens. The fearful investor remains on the sidelines until much of the recovery has already occurred. The main problem, and the cause of much wealth destruction is that the re-entry point tends to be so much higher than the exit point, because it takes a strong recovery to rebuild the confidence required to resume investing. This is otherwise known as ‘sell low, buy high’… (repeat until broke!)

As we see below the post-GFC recovery was 67 per cent between March and December 2009.  Most investors who went to cash did not re-enter the markets until sometime after December 2009.

To summarise we demonstrate a real case example of a disciplined client’s investment experience during and post the GFC.  This portfolio has generated about $200,000 of retirement income each year, and during the GFC the portfolio fell significantly. Our client, a disciplined investor, remained on plan and rebalanced along the way. They continued to draw their retirement income and their portfolio recovered.

While doing something in times of turmoil is a compelling feeling, we need to remember that all Capital Partners portfolios are carefully constructed with clients needs in mind, they are very diversified and very secure.

Please stay safe.  We’re thinking of you!

Source: Capital Partners (with thanks!)