Short-term sentiment versus long-term realities

Global equity markets have been in reverse since the start of the year. 

There are various reasons for this, most notably:

• Higher than expected inflation.
• Higher interest rates in response to higher inflation.
• The Russian invasion of Ukraine particularly putting pressure on commodity and oil prices (read higher inflation).
• China’s Covid-19 restrictions (read reduced production and lower demand from the Chinese consumer).
• More recently, downward adjustments of economic growth prospects.

It is therefore not one specific event, but a convergence of various factors that are currently contributing to the weaker markets. Opinions on what we can expect from the markets in the coming months, are the most diverse I have ever seen in years.

However, there are a few important observations from history I would like to share:

S&P 500’s annual price movement and peak-to-bottom declines (max drawdowns)
The graph below shows the price movements of the US S&P 500 Index for the calendar years (blue bars) since 1996 and the peak-to-bottom decline (red dots) in every calendar year.

Source: PSG Wealth

For example, in 2020, amid Covid-19, the S&P 500 Index ended the year 16.26% higher after a decline in March to a level of 34% lower than the previous high reached in February 2020. From 1996 to 2021, the average return per calendar year was 6.94% and the average peak-to-bottom decline 15.58%.

Important lessons for long-term investors are:

• Material price declines and high volatility are common occurrences.
• Markets generally rebound strongly after such price declines.
• Shares are not post-office investments without volatility.

Sentiment among US retail investors

Source: American Association of Individual Investors (AAII)

The American Association of Individual Investors (AAII) does a weekly survey on the market expectations of individual investors for the next six months. The 4-week average reading recently reached the lowest levels in the past 10 years. This is indicative of how negative current sentiment towards the American market is., This reading has been lower only 15 times (out of 1 815) since the inception of the survey in 1987.

These readings are, however, a recognised contrarian indicator. History has shown that when sentiment was so low in the past, the S&P 500 Index generally delivered above-average returns in the next six months.

These are simple benchmarks, but they offer a degree of comfort to investors who may feel punch-drunk after the selloff in the markets in the past few months, especially for those who are invested abroad.

According to Warren Buffet, fundamentally, there is no difference between purchasing an entire company and buying a share in the company. This view should remind investors that their equity investments represent interests in underlying companies. Markets and economies go through cycles, interest rates move up and down, and geopolitical crises occur continually, but businesses (usually) don’t change overnight.

The AAII bull-to-bear ratio and S&P 500 Index graphs are a reminder of how volatile sentiment can be over the short term. For long-term investors the S&P 500 Index graph specifically serves as a reminder to stick to their investment plans amid uncertainty.

Markets may decline further, but given the above, it is more likely that the market support over the last couple of weeks may lead to further recovery.

This article contains general information only. It does not constitute financial, tax, legal or investment advice and the companies in the PSG Konsult Group do not guarantee its appropriateness or potential value. Since individual needs and risk profiles differ, we suggest that you consult your qualified financial adviser if necessary.

PSG Wealth Financial Planning (Pty) Ltd is an authorised financial services provider (FSP 728).