We often bump into an acquaintance and they will marvel at the market either being up or down over the past few days. But how relevant is the actual market as a concept to investors, especially given the extremes we have seen over the past few years leading to very different experiences in different areas of the market? Investors need to let go of the idea that the stock market is one uniform entity. Such thinking implies that all shares are behaving in a similar way. While investors like to see themselves as unbiased decision makers, prevailing market narratives can often cause investors to lose sight of the bigger picture, relying on recent winners to keep carrying performance, and avoiding areas which do not get positive press. Our decisions to buy or sell, and the price gyrations of shares themselves, should always be seen in the bigger market context. The price we are prepared to pay for an investment should be the result of the expected probabilities of a range of future outcomes.
Even great companies don’t always make good buys
A popular myth holds that if you buy shares in good companies and hold them long enough, you will make money. For example, the compelling narrative behind big tech has driven the prices of these shares to extreme valuations, apparently proving this point. But the ‘share prices of good companies only go up’ narrative is not always true. Pay too much for your initial investment based on valuation and you are likely to wait a long time (sometimes even a decade or longer) to see growth on your investment. The Japanese market is a good example of how a large group of companies represented in the Nikkei Index became very expensive in the late 1980s. Japan as a country, the Nikkei as an index and many firms in the Japanese market, could just do no wrong. Property values and price-earnings ratios rose and rose. You might even have been fooled into 'safety' by buying the index at the time, seeing that as a passive investment, even though in 1989 the Nikkei Index traded at almost 60 times earnings. Of course, every investment decision turns out to be an active one and buying the Japanese 'market' in 1989 led to entering an investment at a level not seen again for over 30 years. This is an extreme example, but it makes the point well. Buying a share ‘at any price’, either individually or as part of an index, is neither a sound nor sustainable investment strategy and ‘fear of missing out’ does not provide a sound basis for robust portfolio construction.
Nikkei 225 Index price levels
Patience and perspective let you see the bigger picture
There are costs to buying into prevailing narratives, and those who are serious about building wealth in the long-term realise that a sound investment strategy has several facets. Avoiding a share simply because its share price has not performed ‘well’, or selling it because it has not ‘done as well’ as some others, is as precarious a strategy as buying a share at ‘any cost’. Many basic passive index trackers do this by virtue of being price insensitive market participants. While index investing can be a good contributor to an overall portfolio, the narrower a market becomes, the more risks increase (such as portfolio concentration or lack of diversification), and the more you need to broaden your exposure. The challenge is that momentum and sentiment can carry popular areas of the market into the stratosphere, fuelling the belief that winners will remain winners indefinitely, just because they have been so far. Investors picking shares without considering the bigger picture or the long-term plan, are likely to be disappointed when prevailing conditions turn out to be substantially different to the conditions that had pushed these valuations up in the first place. Don’t be fooled by the tide – now more than ever, the market is not one amorphous mass. Different parts are behaving in vastly different ways. Sound investments are made when you base your decisions on a sober assessment of fair value, ensuring that your portfolio can withstand several future scenarios. This remains the only sure-fire way to ride out ebb and flow that is part and parcel of investment markets and create portfolios capable of building long-term wealth
Anet Ahern is the Chief Executive Officer of PSG Asset Management.