Equities
With world markets looking like they will end the year well, it remains somewhat stunning just how disbelieving most people are about the strength of global equity markets.
This feels like the least euphoric rally I can remember in my 25 years in equity markets.
My general view is nowadays, investors have an unprecedented amount of short-term "noise" to navigate through. This "noise" is highly distracting and unlikely to lead to investors getting the maximum reward available from their equity investments.
Equities are volatile in the short-term, that is the nature of the beast. This is particularly so with high-frequency trading dominating the daily equity liquidity picture. There are even algorithms that trade off Twitter headlines!
However, over the medium to longer-term, the attraction of equities is the availability of compound total returns. You will only feel the effect of the compounding process if you invest for the medium to longer-term and resist the temptation to sell on every scary Twitter headline.
There are very few great short-term traders in the world because successful short-term trading is counter-intuitive to the basic makeup of average human psychology. Great traders sell into euphoria and buy into panic, which requires a different internal setting than most people are equipped with. Instead, what we need to do is really focus on being an investor. An investor's friend is time, duration, conviction and fundamental research.
I did publish this in a Livewire “key charts” series a while I ago, but I think it’s worth highlighting it again as the experience over the last 4 months supports what this chart is trying to portray. If you get the “timing” wrong, as most people will, it will severely effect the returns of your equity portfolio.
The chart below shows the MSCI World Net Total Return Index (USD) over the last 15 years (dark blue line) and the compound average growth rate it delivered of 7.1%pa.
Source: MSCI, AIMNow we are going to explore what effect being “out of the market” on the “best” index return days had on annual returns. The red line shows the return generated if you exclude the “best 5” index return days in the last 15 years. The grey line shows the return generated if you exclude the “best 10” index return days in the last 15 years. The light blue line shows the return generated if you exclude the “best 20” index return days in the last 15 years. The green line shows the return generated if you exclude the “best 30” index return days in the last 15 years. The purple line if OECD G7 inflation.
Source: MSCI, AIMYou can see in the chart above the dramatic reduction in annual return that “missing” even a small number of “best” index return days generates.
If you missed just the 5 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 4.8%.
If you missed just the 10 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 3.1%.
If you missed just the 20 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to 0.8%, or less than inflation at 1.7%, a negative real return.
If you missed just the 30 best index return days in the last 15 years, your compound annual growth rate drops from 7.1% to -1.1%, negative absolute and real returns.
Yes, historic performance isn’t a guide to future performance, however the evidence above clearly reminds you of the importance of being invested on the major index up days. If you miss the major index up days you will miss the compounding effect of being invested in equities as an asset class.
Historically many of those major index up days have come after periods of index weakness, volatility and uncertainty. 2019 has been exactly the same and started from a very low point after the December market falls in 2018. But it wasn’t just the recovery from the 2018 lows, even the last six months has been very volatile.
The chart below is of the S&P500 over the last six months. It confirms that the return from the mid-August lows alone is now greater than +10%. That is akin to missing out on more than the annual average compound return from global equities over the last 15 years, in just 4 months.
Source: BloombergI realise its an over-used cliché, but it’s right. Successful equity market investing is about time in the market, not timing the market.
What I’ve done in 2019 is cut all unnecessary noise of out my investment process. This is to the displeasure of the stockbroking community and to the benefit of my investors.
When you remove yourself from the noise and focus on long-term fundamental investing in the best businesses in the world, you will be positively surprised by the results compounding delivers over time.
Stay the course, it’s a long game...
Invest with conviction, not momentum
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Comments
Sanj G.
Interesting and right on a lot of things Taking out the best 5/10/.. days is not an accurate way to compare returns, for it does not account for the investor buying in at lower share prices and amplifying the returns. E.g BHP - forgoing prior better performance days on lead up to $26 - $31 and then buying BHP at $13 -$19 range in wake of Brazilian dam disaster would drastically change the outcome contrary to what the graph shows Yet, no one can get all these low ranges right, so a balance of time & timing is the key & it makes a significant difference to the returns! IMHO. Sanj Gandhi
Ryor Poland
You've modelled omitting the best days. For balance carry out the same exercise omitting the worst days.
Graeme Holbeach
I get the idea, but not sure about the argument. One could take the opposite view and only publish the affect of missing the Worst 5 days, Worst 10 days etc. Wouldn't it have been better just to publish the affect of missing the Best 5 AND Worst 5, Best 10 AND Worst 10 etc. to start with?
Charlie Aitken
Thanks for the comments Sanj, Ryor and Graeme. I suspect we are not too far apart in our views. Clearly, missing the 5/10/20/30 ‘worst days’ over the last 15 years would lead to returns that look much rosier than the benchmark. Oddly enough, of the 60 days in question (30 best days and 30 worst days), a full 27 occur during the fourth quarter of 2008 (16 down and 11 up days) – in other words, when the GFC hit. The tricky thing is that the period had several consecutive days of substantial downwards moves, followed by a pattern of two or three ‘up’ days. Realistically, most investors would consider reducing their allocation to markets on a ‘down’ day – the loss aversion effect is hardwired and powerful. As a result, it was unlikely that this theoretical investor who cashed out on a big ‘down’ day would be meaningfully invested when the big ‘up’ day came along shortly thereafter – hence my comment about the rarity of great short-term traders. Personally, I remember those days, and I’ll vouch for the fact that with markets dropping 7% in a day, very few people were willing to commit money into the drawdown. To the point Sanj makes, using volatility like this to increase exposure to equities is the correct thing to do, and hopefully where an active manager (or the astute allocator) can look to generate long-term compounding in real terms. My goal was to highlight the fact that volatility is part and parcel of equity investing, and investors should expect to face it with some regularity. It’s important to have a plan to deal with it. Staying the course and remaining invested is the better long-term strategy, in my opinion. I completely agree thought that if you successfully trade moves like this, the returns would be much better.