Time on our side

Since our last note equity markets have continued to climb the proverbial ‘wall of worry’, with the technology sector leading the charge, ascending to all-time highs.

To many this seems incredible. How could markets possibly recover amid so much uncertainty? This question is being increasingly posed to us and we know many investors are considering selling some of their investments, having experienced such a rollercoaster this year.

So how should we answer this question? Firstly, it is worth understanding our very nature as humans.

It is well-documented that we feel loss much more keenly than gains. Indeed, it is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining.

Having experienced some pretty uncomfortable ‘losses’ earlier this year, it is human nature to want to sell when you ‘recoup’ these losses. After all, who wants to go through that pain again?

This simple observation also explains the very poor returns we observe when looking at the long-term performance of private investors. The urge to sell and to get out can be very strong and, the evidence shows, very detrimental to long-term returns.

Secondly, there are very understandable reasons why the market has recovered. Never before have we seen such a concerted effort to support the economy. The response to this crisis from governments and central banks has been truly epic and we have seen the impact in recent economic data.

This is not to say the data will not deteriorate in the future, but I am increasingly asking myself what the required return from equities should be when the economy is so supported by governments and central banks.

Looking at valuations today, the long-term equity investor should earn returns of c.5% more than the long-term bond investor. It is possible that in the future investors will demand more from equities, in which case equity values will fall, but a c.5% differential is quite high by historic standards.

Of course, this potential excess return from equities is also a function of very low bond yields. So, I am not arguing for very high equity returns here. However, c.5% over bonds/cash is not bad and we must also ask what if the required excess return from investors falls to c.4% and bond yields stay as they are? Well, that would mean equities would appreciate by 20-25%.

The point I am trying to make here is that the equity market does not look especially overvalued today.

Thirdly, as discussed in our last note, I don’t believe we should ignore the possibility that we are in the midst of a very long-term bull market, supported by advances in technology and productivity, and that this year’s setback was an interruption of that longer-term trend.

Whilst it is arguable that there is some exuberance in certain high growth stocks today, we must also recognise that we are witnessing a remarkable acceleration of digitisation. We are certainly seeing some stunning growth numbers from businesses benefitting from this trend and in many industries digitisation is still nascent.

If we are in a major long-term, technology-driven bull market, it is very unlikely that the equity market will be accommodating and let those who have sold, back in at lower levels.

This brings me to my final point. It is just too hard to time markets. Perhaps investors selling today will be right/lucky and the market will correct 10-20% and they will buy back in cheaper.

However, having worked in financial markets all my career, I keep coming back to this Peter Lynch quote whenever clients ask me should they ‘go to cash’:

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves”.

Of course, in some cases raising cash may be the right thing to do and investors should regularly review their investment plan. However, in doing so, it important to recognise that investors with a considered long-term plan will likely enjoy the best returns. At least that is what the evidence suggests.

As always, please do not hesitate to contact us with any questions.

Ian Quigley
T: +353 1 421 0300
E: ian.quigley@brewindolphin.ie

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