Where do we stand now?

“Everything feels unprecedented when you have not engaged with history.” – Kelly Hayes

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Investment Strategy

World stock markets have had their worst start to a year since 1939. Try to take your mind back to some crises that have taken place from then until now. With the war in Ukraine currently underway, let’s just look at a few wars:

  • 1939 – 1945 World War II
  • 1950 – 1953 Korean War
  • 1955 – 1975 Vietnam War
  • 1990 – 1991 Gulf War
  • 2003 – 2011 Iraq War

And these are just the relatively well-known ones.

Then there have been quite a few financial “wars” as well. Take your mind back to some recent events such as the Enron scandal, European Debt Crisis, the Great Financial Crisis, BREXIT, Donald Trump, Zuma and two finance ministers in so many days, Covid-19…

Things that have never happened before are happening all the time.

There are three aspects of investing and investment strategy that advisors and their clients should have clarity on to make it through these times: 1. Arbitrary market periods, 2. Appropriate asset allocation, and 3. The psychology of the market.

Be aware of what your client is investing for. Be sceptical of the media trying to influence them by what is happening in the short term.

“The only relevance of a one-year time period is that it is the time it takes earth to go around the sun.”

The headlines that hit the hardest get the most attention. To substantiate, as at the beginning of the piece, that stock markets have had their worst start to a year since 1939, hurts. It causes anxiety. But this is not uncommon. Returns are discussed by referring to stock market returns “Year to Date”, or what happened in the last quarter, the first half of the year or the reference to a specific year.

The question is whether a specific period really matters? The answer is yes, but the period of application differs for everyone.

If clients want to achieve a goal with their finances and investments, there is usually a period attached. For example, clients want enough funds to send their child to a prestigious university. A client wants to save enough to take three years off from work or have enough to be financially independent. And then probably the most common, to save for retirement.

Given assumptions and inputs, clients need a certain return to reach their goal at a set time. So, what happens during any arbitrary time of a year or six months has very little to do with that specific goal.

Context is so incredibly important. If a client has 25 years left before retirement, the year-to-date returns of 2022 are of very little importance. If the client wanted to tour around the world in 2023, and they did not have enough funds to do so and took a chance on putting all their money into the stock market in 2022, then it does matter. The holiday will have to be put on ice for a while.

Be aware of what your client is investing for. Be sceptical of the media trying to influence them by what is happening in the short term.

Most prices on world stock exchanges are still determined by people.

But also, be aware of what they are invested in, point two.

If clients draw income from their investments, this portion of their investments is not supposed to be heavily exposed to “the worst stock market start to the year since 1939”. The portion of their investments should be much more stable than what goes on in stock markets.

“Never let a good crisis go to waste.” – Winston Churchill

The past few months have been a golden opportunity to determine the sustainability of a portfolio from which income is drawn. If the portfolio is sharply down, there is quite possibly too much exposure to stock markets and the asset allocation needs to be reviewed. If the portfolio is a little off, or even possibly a little up during such a volatile period, the allocation is quite possibly in line with what is required of such a period.

This is also a good time to revisit the exposure of your long-term growth portfolio.

If a portfolio is positive during the period, you should ask what was the exposure that led to a good return? Since the beginning of the year, most stock markets around the world have been down. These include the JSE, Eurostoxx50, Dow Jones, NASDAQ, S&P500 and many more. There were one or two areas of the market that performed well.

In South Africa, financial stocks were up, as were resources. The FTSE in London delivered a small positive return. And commodities like oil, gold and palladium.

The purpose of the exercise should not necessarily be whether an allocation was “right” or “wrong” over such a short period of time. The exercise should rather expose to an investor whether they know what their allocation is and whether they are comfortable with it.

If a client’s portfolio is down 15%, but they are comfortable with the international equity exposure they have, with the belief that there will be growth over the long term, then there is no problem with the allocation. If the portfolio is up by 25%, and they are not comfortable with the 50% allocation to oil in the portfolio, the portfolio allocation should be revisited.

We forgot that when you borrow money, you borrow from the future. You bring consumption in the future to today, but you must pay for it. The price for that is interest rates.

Use fewer good times like these to make sure clients are comfortable with their asset allocation. Also remember to do the exercise when it is going very well. And that brings us to the psychology of the market.

Howard Marks, one of the most famous investors of our time, compares market psychology to a pendulum that swings from great optimism to great pessimism. Think of it this way. During our childhood there was a triangular box that was used to indicate pace when you play the piano. The pendulum swung from one side to the other and tapped-tapped to the desired pace. When the weight on the pendulum was shifted to the top, the pace was longer and slower. Once the weight was moved downward, the pace accelerated and the pendulum swung faster from left to right.

This is how the psychology of the market works. Most prices on world stock exchanges are still determined by people. Humans are emotional beings. We are not computers. We interpret what the world looks like today, what we expect in the future, and this infers our emotions. And there is very rarely a Goldilocks moment where everything is just right, where the pendulum stands still in the middle, and markets reflect the future 100% correctly right. We are either too positive, reflecting high prices in the market, or too negative, pushing prices down to low valuations.

Hannes Viljoen, CFA, CFP®, CEO and Head of Investments, Kudala Wealth

Covid-19 was just such a case. Within a few months, world markets were down by a third, the market reflected that there was a major recession or even depression in our future. Great pessimism! As time went on, we better understood the virus, and there were rumours of a vaccination, our pessimism turned in the fastest time in history to optimism. We will get through this, and as soon as we get through, things will go very well again, for a very long time! Prices went up. There is nothing that can stop us now. Billions were poured into technology companies making losses. But this is not a problem, somewhere in the future they will make a profit, so no price is too high. Great optimism!

We did forget, in the background, that debt incurred to keep the economy going during the pandemic is not free. We forgot that when you borrow money, you borrow from the future. You bring consumption in the future to today, but you must pay for it. The price for that is interest rates. And when interest rates go up, like now, then the price of your historical consumption rises and your ability to consume in the future diminishes.

And then came the war, which was not the main reason for recent events, but which set the snowball in motion. There are usually a variety of things that cause a situation.

The question is, where is the pendulum now? Are we only at the beginning of the pessimistic swing and things are going to get “much worse” from here? Is this just the beginning?

I hope not, but I do not know. Nobody knows.

What I do know is that humanity is a species that will continue to grow, continue to improve, continue to innovate… and when the economy starts to grow well again, when the clouds lift, it will reflect in the stock market. Prices are going up again.

I do believe a diversified equity portfolio is the best place to be for long-term wealth growth. And here I am not alone. The trick is to convince your clients to sit on their hands when others throw in the towel.

We are going to have another period where the party will get so out of hand and that prices will become too high again that it is not sustainable. This is the nature of the pendulum and our species. But if you, and your clients, can keep their head when others are losing theirs, the music is going to be blissful in the long run.