The natural instinct in turbulent times like these is to press the panic button – sell any investments which could potentially fall further and retreat to the safety of cash. However, while this may provide some welcome short-term relief, it is unlikely to prove a fruitful strategy longer term for three main reasons:
First, while cash will clearly hold its value in nominal terms, it is unlikely to do so in real terms. This is particularly the case in times like now, when inflation is running as high as 10%.
Second, bonds once again have a reasonable yield. UK gilts, which were yielding a measly 1% or so at the start of the year, are now paying 4%. The process of reaching this higher yield has been painful with gilts posting losses of over 20% this year. But bond yields in both the UK and US are now at their highest level in ten years and medium-term prospective returns are looking considerably better and rather higher than for cash.
Third, global equities are now down over 20% in local currency terms from their high and have de-rated substantially. The price-earnings ratio has fallen to 13x, some 35% down from its highs of a year or two ago and close to 20% below its long-term average. Most of the bad news should therefore now be priced in, although equities look certain to remain volatile for a while yet. The main downside risk from here lies in the pressure on corporate earnings coming from a slide into recession.
This is not to say it will be easy for the UK Government to restore investor confidence after recent events. Rather, cheap UK valuations more than price in the poor economic outlook. The UK also typically makes up only around 30% of our equity exposure and the pound remains a relief valve for our portfolios. Further UK political or economic ructions would inevitably put renewed downward pressure on the currency, boosting the value of our overseas equity holdings in sterling terms.
As we highlighted last week, there have been numerous crises and sizeable sell-offs over the last 50 years and yet equities have always managed to recover and produce long-term inflation-beating returns.
Equally important, trying to time a market bottom is very difficult. Where there is a clear catalyst behind a rebound, the difficulty is predicting it accurately in advance. Where there isn’t, a rebound may simply be sparked by signs that conditions are not quite as bad as markets had feared. Either way, bottom-picking is usually a fool’s game.
Getting out, but then failing to get back in on time, can prove expensive. The early stages of a bull market are generally the swiftest, with US equities typically gaining around 20% in the first three months of a recovery and 35% over the first year. Even missing just a few days can be costly. An investor in UK equities would have increased their money 18x over the last 35 years. But if they had missed out on just the 30 best days, they would have merely increased it 3x.
In short, in times of acute market stress, the best advice is to resist the urge for draconian action and instead contact your investment manager or financial advisor. A little distance from the portfolio in question, along with a reminder of the lessons to be learnt from investment history, should hopefully remove the urge to press the panic button.
Rupert Thompson – Investment Strategist