2010: An Investing Odyssey

A long, wandering and eventful journey.

There’s not much point in rehashing 2009. If you hibernated through it you missed a good whipsawing by the stock market and your investments are probably doing much better than they were at the beginning of the year. If you panicked at the beginning of the year and sold up, my commiserations, and if you seized the opportunity to buy, congratulations.

Unlike most pundits, I’m resisting the temptation to rehearse 2010 too. Predictions are dangerous because they’re generally wrong, which means making them is a waste of effort and believing them can lose you money.  Ken Fisher’s preferred method of predicting market returns used to be to look at all the other pundits’ predictions and pick the most plausible outcome that wasn’t the consensus. It worked well, until other prognosticators learned the trick.

But my lack of faith in fortune telling, does not mean I’m blasé about the future. I just prefer to stick with what I know, which is why I take the market’s temperature every week. Of course, it’s temperature isn’t measured in centigrade, I use the 10 year price earnings ratio, a calculation that determines whether companies are cheap or expensive relative to their earning power.

Genuinely cheap shares make very good investments and In March, UK shares were very cheap, costing about eight times earnings. A year and a half earlier they were expensive, costing over twenty times earnings. It seems obvious in retrospect that investors should have sold in 2007 and bought in 2009, but what about 2010?

The 10 year price earnings ratio has been stuck around 14 since last September implying an average annual return of 7% for UK shares. It may not sound like much, but government bonds pay about half that. Don’t even mention interest rates on savings accounts.

As we enter 2010 the stockmarket still looks like a fairly sensible place to invest, although, and contrary to the feelings of many investors at the time, nowhere near as safe a place as it was last March.

In his book, The Greatest Show on Earth, Richard Dawkins describes one of the criticisms of the theory of evolution: the lack of ‘intermediates’, fossils that are neither one species or another, modern humans or Australopithecines for example. That’s like saying there’s no intermediate stage between childhood and adulthood, he says. Legally children are adults on the stroke of their eighteenth birthday, but the law is just a convention, and everybody recognises that children gradually turn into adults. The names we give our ancestors are conventions too, he says, and for the sake of convenience we shoe-horn the intermediate fossils into one classification or another.

Much as it would be convenient to shoehorn the stockmarket into the ‘cheap’ or ‘expensive’ category now, it’s in an intermediate stage too, although the next step could be backwards or forwards. Knowing where we’re starting though, is very helpful in determining how we might respond to events in 2010.

Long ago, Benjamin Graham outlined a strategy for coping with varying market conditions. In an interview (Medical Economics, 1976) he recommended investors buy shares and sell bonds when shares are cheap and sell shares and buy bonds when shares are expensive:

In times like the 1974 drop, when you find many good companies whose stocks are selling at low PE levels, you should take advantage of the situation and put up to 75% of your investment capital into common stocks. Conversely, in periods when the market as a whole is overpriced you’d have trouble finding stocks to reinvest in that meet my criteria. In such periods you should have no more than 25% of your funds in stocks and the rest in, say US Government bonds.

Graham’s criteria were sound companies at cheap valuations, a concept I copied in creating the Thrifty 30 model portfolio last September. Not surprisingly then, especially as over half of the 30 berths in the Thrifty 30 are now full, I’m going to take Graham’s advice. If the market gets more exuberant as 2010 progresses I will be more cautious, and if the heat falls out of the market I’ll be more confident.

I’ll probably stick with cash, rather than a bond ETF, say, because I’m not sure the extra return from bonds is worth the trouble and expense of dealing in them, and, while keeping some cash might dull returns in frothy markets, having cash to spend should the market crash again will both:

1. Protect the Thrifty 30 from the worst of the crash, and…
2. Give me buying power when shares are cheapest.

A correspondent tells me this practice has evolved into a discipline in its own right, tactical asset allocation, although Graham probably thought it was common sense.

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Postscript: In butchering the titles of two Arthur C Clarke novels I got the title I wanted for the first market-focussed blog of the year. An odyssey is a long, wandering and eventful journey and in that respect, I think 2010 will be much like 2009 and every other investing year. It may sound trite, but if you prepare for a wandering eventful journey, you’re less likely to be dismayed when it doesn’t turn out exactly as you had imagined!

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A long plodding journey.

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Bjorn Lomborg says we should spend less on trying to cut carbon emissions and more on developing alternatives.

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Edmond Jackson profiles Thrifty 30 candidate Game.

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