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Point of View

Traversing bumpy roads

Brexit, US politics and an uncertain inflation outlook are just some of the things threatening to obstruct our markets. We explore sound investment pathways for these unpredictable times

If a company has a great business and a good track record, we can be fairly confident it will fight off future threats.
 
In the wake of Britain’s vote to leave the EU, the FTSE 100 index fell more than 5% and the FTSE 250 index by almost 16%. Company share prices were marked up and down, while pundits predicted all manner of market outcomes – from housebuilding slumps and banking turmoil to retail price wars and exporting windfalls.
 
166272860v3.jpgWithin a week, however, the FTSE 100 had recovered all the ground lost and more; the FTSE 250 took a little longer, but by the end of July it was trading above its pre-referendum level. While the referendum result was undoubtedly significant, market traders soon realised that companies were continuing to trade, banks to lend and consumers to buy much as they had done before they voted.
 
Sudden swings in market sentiment are not uncommon. Falling oil and other commodity prices, Chinese currency devaluations, US interest rate rises, Greek bailout talks: these are just a few of the things that have caused sharp falls in share prices in recent years. But, these were all usually followed by an equally sharp recovery.

Such gyrations in the market are undoubtedly unnerving – especially when the usual TV pundits stoke the fire with predictions of sector or company nosedives. Indeed, many investors, particularly inexperienced ones, will be tempted to sell when they see prices falling. However, evidence shows that it’s misguided to sell on bad news. A ‘buy and hold’ strategy, focusing on backing quality companies for the long term, is far more likely to produce good investment returns.
 

Veering off course

Philip Smeaton, Chief Investment Officer, explains: “By definition, the future is always uncertain: at any particular time, you can list a number of things to worry about. But very often, market traders will convince themselves that something is certain when it is not. For example, at the beginning of 2016, markets were convinced that commodity prices would be weak for the long term. This then filtered into concerns about the balance sheets of banks that had exposure to commodity companies.
 
“In spite of this, we decided to add to commodity exposure at the start of the year. Instead of worrying about that period of uncertainty, we focused on the fact that we could buy commodities more cheaply than before. Ultimately, we felt we could benefit when prices stabilised.”
 
Our approach, says Smeaton, is to look for companies with good prospects, regardless of the current mix of uncertainty. “When we do our research and analysis, we want to determine that more good things can happen to the business than bad, and that we can be relatively confident of their managers’ ability to invest the company’s cash sensibly.”
 

A broader viewpoint

Of course, sometimes events are so dramatic that they do change the investment landscape – the financial crash and banking collapses in 2007 being prime examples. But the fact remains: because our globalised international economy is so complex, it would be unreasonable to expect one single entity to reliably forecast what’s going on at any point, no matter how well qualified or experienced its committee members may be. So, rather than try and predict the unpredictable – whether we’re set to see France follow Britain out of the EU or witness the break-up of the euro – we believe it is better to focus on the price and underlying characteristics of the investment itself.
 
“We ask ourselves whether we’d still want to hold an asset, even if a severe external event changed the landscape completely,” he says, “and then assess what price we’d be prepared to pay for it.”
 

Staying on track

After all, even the best-informed investor may not time markets perfectly; many will tend to sell when share prices are at or near the bottom and buy back when their recovery is well-established. Indeed, there are numerous analyses underlining the folly of reacting to market events, no matter how severe they appear at the time.
 
For example, investment bank Morgan Stanley* analysed investment returns from the US S&P 500 for two groups of investors: one of which stayed invested throughout the period; another of which, in trying to time the market, missed out on its best 12 months’ performance. While the former group would have achieved a return equal to 8.1% a year in the decade to September 2014, those who dipped in and out of the market would actually have lost an average of 0.62% a year. The effect even persisted over longer periods: Morgan Stanley’s analysis showed that, over 30 years, the ‘buy and hold’ group made an average of 11.23%, compared with 7.08% for those who missed the best months.
 
Wholesale moves in and out of the market are rarely a good idea – a notion that Tom Stevenson, Investment Director for Personal Investing at Fidelity International, concurs with. “Firstly, the trading costs involved are too high to make such a radical move sensible,” he says. “Over-trading always eats into investment returns and is best avoided. Secondly, markets are great discounters of news.
 
“It is also worth remembering that staying fully invested through market cycles makes sense, because missing even a handful of the best days in the market can seriously compromise your long-term returns. The best days in the market invariably follow close behind the worst ones; time in the market matters more than timing the market.”
 

Reaping rewards

With all this in mind, one of the key things to consider is the extent to which economic and market uncertainty is reflected in the price. “We have to look at the company’s existing business and what we expect to happen,” he says. “If a company has a great business, offers compelling products and is led by a strong management team with a good track record, then we can be fairly confident that it will be able to fight off future threats.
“After that, we look at what we are being asked to pay – the company’s share price – to determine whether we will get a sufficient return for our money.”
 
While investment should always be for the long term, with a time horizon of at least five years, it is also important to think about shorter-term opportunities as part of this long-term approach. He cites the example of Alphabet, owner of Google, which was relatively under-valued by investors a year or so ago. “Then the market recognised that, in fact, it was an excellent company and was doing very well, and the price took off in a short space of time after drifting sideways for 12 months.
 
“That demonstrates that market sentiment can quickly rotate. Our approach at Sanlam is to be patient and trust our analysis. That way, we’re confident we’ll get our reward.”
 
If you want to discuss how we work to keep your finances afloat in uncertain times, speak to your Sanlam portfolio manager or your financial adviser
 
* morganstanley.com/spc/knowledge/managing-wealth/research/market-timing-is-a-losing-game.html
 

Investing involves risk and the value of investments and the income from them may fall as well as rise and are not guaranteed. Investors may not get back the original amount invested.