Our basic strategy is to be extremely patient, sell into strengthening markets and buy back into any weakness and maintain higher than usual cash balances to protect capital given our big picture view of the world. We believe we are in a long-term bear market that will be punctured with many positive rallies then followed by market falls as market confidence quickly fades.
Matthew Hol, January, 2013
How We Look At Markets
“I firmly believe that investment markets are an accurate depiction, in real time, of investor expectations and so movements in broad markets are a reflection of broad social mood.
Expectations, or levels of social mood, are also captured in broad economic numbers but only after a long lag that may be six months or more. This makes predicting markets by forecasting the movements in the economy a real challenge, an accurate forecast of where the economy will be in six to twelve months likely explains why markets are where they are now.
Swings in social mood or expectations, driven by the numerous behavioural biases that drive humanity, from pessimism to euphoria and back, over periods of six months to a few years are the primary drivers of cyclical moves in markets over similar periods; valuation tells an investor nothing over such time frames. Valuation is important as an indicator of where a market will likely go over the very long (secular) term. All markets display secular bull and bear markets that may last three decades or more and the inflection point from secular bull to secular bear is always accompanied by historic extremes in valuation. Over the very long term, long term measures of valuation are an exceptional indicator of long term prospective returns.”
Kevin Armstrong 2000
Kevin Armstrong is a world renowned and respected investment strategist and successful manager of money. I chose this passage from Kevin’s Strategy Thoughts paper back in 2000, as I thought it best described the human rationale for making investment decisions, economics and the need to understand the context of long term investment cycles. If you understand the context in which you are investing in, that a very good start in how to best preserve your capital.
Monitoring levels of fear and greed within the investment cycle is an important aspect in the investment philosophy in our investment decision making process. Fear and Greed and succumbing to these emotions can have a detrimental effect on an investor’s portfolio value as investors and their advisors become overwhelmed by these two emotions as a way of making their investment decisions. The reverse can apply to making investments that you are comfortable with because you have been comforted by the recent good returns from a particular asset. Rarely do comfort and great investment outcomes go hand in hand as often when you are comfortable with an investment, much of the investment returns have been paid out to the early investors already who bought when they were uncomfortable and had much more doubt about returns that weren’t obvious to other investors.
Timing is everything with investment markets. The moment an investment is bought or sold does make a significant impact on the ultimate profit or for that matter, what loss is potentially incurred.
Market timing involves the very difficult task of using the investment skill of buying, holding and selling investments at the right time to generate returns over a more passive holding strategy. The strategy may encompass selling an investment at a high price in the hope of buying it back in the near term at a lower price or alternatively, moving the redemption monies to another investment that will provide a better return than the original investment.
On detailed analysis, world share markets experienced a secular (multiple business cycle long term trend) bull market from 1983 to effectively the end of the year 2000. During this time asset prices steadily increased for 17 years. A passive hold strategy would have provided the best outcome, as this strategy would have allowed for the maximum exposure to growth assets and would have mitigated transaction cost and realised tax costs, due to the low or no turnover of investments.
However, in the current environment, timing the markets is more critical to capture returns, as long-term capital growth cannot be relied upon given weak world economics, diminishing investor sentiment and volatile markets, demanding that we capture or lock in any short to medium term gains or alternatively limit losses sooner, given our foundation thinking that we are in fact in a secular bear market.
Traditional measures used in the past to gauge whether a market or a share is expensive or cheap in these environments become less of a guide as an indicator to buy, sell or hold.
Perhaps at extreme levels (market highs and market lows) traditional market valuation techniques such as Price Earnings ratios (P/E) or Earnings Per Share (EPS) measures don’t work when the market is in the ‘middle’ ground in valuation, and these traditional measures provide no real assistance in providing a context around asset values. A very good example was the Taiwanese shipping company Evergreen. Back in the mid-80s, Evergreen was trading at a P/E of 60 times. The P/E is now somewhere between 6 to 8 times. So expectations have changed dramatically and we have to be cautious when using old benchmarks.
We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” W. Buffett.*
Please forgive us for the Warren Buffett quote. They can be very overused and a little contrite. There is a lot merit in the contrarian view and is something we endeavour to implement for our clients, but we need to understand the full meaning of Mr. Buffett’s proverb. Mr. Buffett can take a 30 year view. We can’t. We need a “return” generally within 3 years if not sooner for investors. Mr. Buffett can buy companies like BHP now at a relatively low valuation (ignore the commodities cycle) and not look at the share price for 30 years and get an outstanding return assuming China continues to industrialise. We can’t. So we recognise the short comings of the contrarian strategy.
* Warren Buffett is one of the most successful share market investors in the world, having made 10’s of billions of dollars of wealth.
Strong business fundamentals relating to the underlying business is naturally very important.
The qualities of business franchise, balance sheet strength, strength of management, financial track record, earnings growth, pipeline of projects and resources are all important in considering the qualitative features of a business. Ultimately, we want to be buying good companies that do what we expect them to do. We want to buy good credit assets where we are as sure as we can be to get all our money back at maturity. We buy investments where we have a strong line of sight to our investment outcome. We can’t control short term sentiment and if we get our timing wrong, good fundamentals within an investment will assist with asset price and investment return maintenance (particularly when an attractive yield also accompanies the holding).
The 2009 Global Financial Crisis is good evidence of quality businesses suffering market value falls and then recovering reasonably quickly because of the strong underlying fundamentals of the business. A good business remains a good business and when the fear subsides, value can be recovered.