Who’s afraid of the big bad bear?
Posted on May 23, 2007 by Richard Beddard
Filed Under Markets, Investing |
The most popular article I have written for some time was “The Great Crash of 2009“, where I knitted together the ideas of a well known bull, Ken Fisher, and a well known bear, Jeremy Grantham and rather cheekily suggested they were in agreement; that there will be a crash in 2009. The truth is, they don’t know when this bull market will end, they just know that it will. And the point of my article was that, if you examine what they say, it doesn’t look particularly likely it will happen soon.
Speculation about the Great Crash of 2009 caused a minor crash in 2007, although not on the stockmarket. It brought our blog to a halt. Ten thousand people clicked thru’ from Interactive Investor’s weekly email in one evening. Thirty-one people commented and others emailed. You expect people to agree and disagree, it takes all-sorts to make a market, but mixed in the debate were other voices saying, “Well, what do we do about it?”
I’m a journalist, and private investor. I don’t pretend to advise people, though I try to find answers to their questions. But I do have an opinion insofar as these things affect me, and because this is a blog and more like a conversation than a broadcast from the almighty, I’m going to offer a personal perspective on the market’s ups and downs.
A reader sent me this chart (full-sized version), which Scottish Widows have kindly allowed me to publish*1, and the following:
I read your article regarding “The Great Crash of 2009″. I have attached Scottish Widows - UK Financial History 1945-2005. Stockmarkets have always moved in cycles. “The 1972 peak didn’t bottom until 1982,” according to your article. That may have been the case in the US; however, it was not evident here in the UK, even after interest rates peaked at 15% (1977). I started work in the city in ‘72 and saw the FT 30 Share index fall from over 500 to 148 and you could buy the likes of ICI and Glaxo for three bob a share.
I believe we are at the beginning of a sustainable bull market for the next 20 plus years. My reasons are based on the simple premise of ’supply and demand’. More people will have to save for retirement, more mergers and acquistitions, as well as future profitability from companies. Innovations and technology will be the key to this as has been shown in previous bull markets.
Yes, I do accept there will be corrections along the way; however, the trend is your friend for long-term investors.
Past performance doesn’t guarantee future performance; nevertheless my correspondent has provided more past performance than we are accustomed to! Here’s a selection of events, plucked from the chart, some of them tongue in cheek, the market has survived: To start with, 3 C’s:
- The Cold War
- The Cuban Missile Crisis, and…
- Many Conservative governments :-).
Then some economic worries:
- Interest rates at 15%
- Oil prices rising 70% and…
- The UK leaving the European Exchange Rate Mechanism.
Not to mention Grease, Tiananmen Square, 9/11, bombings in London and New York, the Asian Tsunami, and many, many wars. It seems that unless our generation falls victim to an even longer cycle, the waxing and waning of civilisations, capitalism is likely to endure. Admittedly, theories about the end of civilization are fashionable. I’ve even reported on some. But I’m an optimist, and if it does happen on my watch I’ll have more important things to worry about than my stock portfolio*2. As for crashes that happen along the way, I think:
- My portfolio won’t be as badly affected as the market as a whole
- I will recover.
As luck would have it, I started investing in shares on my own account 28 February 2000, the peak of the dot.com bubble. My timing was off. Neither was my first buy auspicious. Many readers who were investing at the time will remember the company. It was Dialog, formerly Maid, latterly Smartlogic, which promptly went bust. A true dot.com share.
But my timing was lucky in one sense. It means I invested through the last bear market.
How have I done since? I have been looking at my portfolio’s annualised returns (a calculation fraught with ambiguity, and a subject I shall return to when I feel better equipped). In March 2003 after three years of falling prices my annualised return was -15%. It didn’t feel like a disaster. I had invested the money for an indefinite period, let’s say 25 years, and I’d done slightly better than the market (although looked at another way, I’d lost about 40%). Counting the current bull market as well, my annualised returns since February 2000 are much better: +17%.
For the sake of illustration, £10,000 invested at the top of the dot.com boom returning 17% a year compounded would be worth about £30,000 now (a 200% gain). Mentioning this is quite painful, because it looks like a boast, when actually:
- I’m a little disappointed by 17%. And…
- My purpose is to explain one of the reasons why I’m not afraid of the big bad bear.
There are more reasons:
- I feel more confident in the shares I own. I have a method. I buy good companies on the cheap. Barring total economic meltdown they’re not going to go bust soon, even if the stockmarket does crash. I wouldn’t buy Smartlogic these days.
- I’ve spread those profits around. What started as a portfolio of four British stocks is now a portfolio of 18. I own shares in a Finnish company (Nokia), and American ones too. Even if there is a Smartlogic lurking, it will have less impact next time round.
- Maybe I sound complacent, but I try not to be. That’s why I talk to people who’ve survived more bear markets than I have. That’s why I’m steadily examining every brick in the wall of worry, many of them identified in the comments on this blog.
When the inevitable happens, I’ll be prepared. I’ll understand what’s happening and keep my head, when all around me lose theirs. That’s the plan*3, at least. And if I’m wrong, at least I’ll have a head start in working out why.
February 2003 to February 2004 was a great year for me. The kind of year investors dream of. My annualised returns since February 2000 went from -15% to +13%. A lump sum invested in my portfolio would have been down 40% over three years, and up 60% over four. If I were spooked out of the market in, say 2010, only to miss the recovery of 2012… Now that would be a disaster…
Footnotes:
- Scottish Widows are updating the chart, and I’m expecting the 1996 version in about a month’s time.
- I am concerned about the environment, it just doesn’t govern the decisions I make in my stock portfolio.
- My plan, that is. I can’t say what yours should be, but I do suggest you need one. I think a good starting place is knowing yourself.
- I also received an email from Robin Soole, a private investor and regular reader of this blog. He’s developed a program to determine his trades and we are swapping emails about which is better - his algorithm, or my brain (usually he’s backing my brain and I’m wondering about his algorithm!) The algorithm is a story for another day, I hope, but it has two ’settings’, low risk and high. I don’t know algorithms from aligators but I do admire an investor with a plan. Based on the assumption the bull market is likely to continue this year Robin says:
“2007 is not the time to be risk adverse. Therefore I am going to allow my portfolio to shift into the high risk version over the next few months and see how it pans out.”
Good luck Robin!
Comments
26 Responses to “Who’s afraid of the big bad bear?”
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Hi Richard,
I really appreciate the mention so I thought I would to be the first to post a reply (its another long one I am afraid).
You and I think along the same lines for sure. You cannot fear the bear market. You must build up your profits during the bull market and then deal with the bear market as best as you can, when it occurs.
This will mainly be a damage limitation exercise (unfortunately following a big crash, which will likely take a big chunk out of the aforementioned profits).
The worst thing about a bear market is that they just go on and on and this is where your plan will really be tested to the full.
About my algorithm, I would never say it was better than anyone else at picking investments except for one person, and that is myself!
Without a shadow of a doubt I trust my program to pick better investments than I could do on my own.
This, incidentally, is more a reflection on my poor stock picking ability than on the quality of my program.
While I have the freedom to manually override the program recommendations, I never do. There is just no point because I cannot predict the future.
For sure, I am curious to know what will happen next.
- How long will the American surge last?
- Will China crash shortly?
- Can JPM Natural Resource just keep on going up!?
- Is Japan suddenly going to surge ahead 50% overnight?
- Will Russia and emerging Europe suddenly lose their glamour as Putin tightens his vice?
- Will the problems in the environment finally start to make ethical investments move ahead of normal investments?
Whatever happens, there will be something else to offset the event as money moves from one place to another. Stay calm and watch out for it!
.
Common sense rules, no over complicated theories just basic insights.
PS. The algorithm system might change my view!
It is curious that neither Richard nor Robin make a mention of the greatest threat to the present stock market: namely, the spectacular bubble in the British housing market which, when it bursts, will have a huge impact on all asset classes. See an interesting website, housepricecrash.com, examine the graph and prepare to be scared, very scared. I can remember the last bear market and its impact on my portfolio: it seemed to go on forever. A prediction: the next will be even longer. Stuart
I am soewhat comforted by the comment made by Robin Soole
“This, incidentally, is more a reflection on my poor stock picking ability .. ”
This reflects what many of my investing colleagues say on a fairly regular basis. It seems that despite all the knowledge freely available these days, we all make bad investment decisions from time to time. Nobody is immune, even the professionals, but hopefully we get more right than wrong and, given time, the risk premium should prove we are right to be in the market and not in the Building Society !
If you doubt your stockpicking ability why not leave it to the fund managers. My fund portolio is easily beating my share porfolio. So is iii’s fund portfolio. After all they do not pay people like Anthony Bolton, Edward Bonnam Carter, Andrew Brough etc to not stay at the top.
Thanks for your comments everyone! Nothing much to add really except I will be examining the significance of house prices to the stockmarket at some point, as part of my determination to come to an overall view on the market and what’s driving it. Like Robin - I’m curious, but also sanguine.
I did take a look at housepricecrash.com. The chart shows B of E base rates. Is that the right one? What’s scary?
I think the point about housepricecrash.com is the shear amount of debt that Joe Public is accumulating. A small interest rate rise at this point could tip a lot of people into the red, resulting in mortgage defaults and house price falls. Drying up of disposable income to service debt could also eradicate a lot of business models with subsequent knock-on effects there.
In short there is a lot of pent up risk aversion out there, which increases the chances of a sharp fall in all asset classes at some point versus a steady decline or plateu.
I recently read The Black Swan by Nassim Taleb and totally agree with his ideas on planning for a few rare (but significant) events rather than long term movements.
Thanks Colin, looks like “The Black Swan” is one for the reading list!
i find it always interesting that we are obsessed with the negative side of things. this world’s going to end attitude appears to be compelling to us all judging by the reponses and hits. but ultimately it is a positive approach that pays in the end. people consistently underestimate the human race’s ability to pull thru and better it’s lot. I believe that we will continue to see a surge in the prices of ALL assets, property included as their is an enormous wall of money out there. It is always good to get differing views though.
As a postscript i would say that many of my friends who would be very high net worth people with good contacts and resources, are very bullish for the next five years. these guys are rarely (never yet!) wrong, but there’s always a first.
My biggest error in the last bear market was being geared up and then being a forced seller to meet margin calls. Without gearing you can ride out most situations.
I think the website being referred to is www.housepricecrash.co.uk which is different from www.housepricecrash.com.
I might be wrong however
Robin
I’d be very interested to know what your algorithm is. I have an urgent need to become a very active investor.
We’ve just been unceremoniously dumped out of our final salary pension scheme and for people like myself in their 40s, it means we’re taking a triple hit: we lose the benefit of the guaranteed pension; our accrued benefits are being calculated as current years of service and salary indexed by inflation rather than actual salary when we leave the company; I’m now having to start saving for a pension late on, so the cost of providing for the remaining year is much higher than in would have been had I been in a defined contribution scheme from the very start!
Hi David,
My investing style is not a get rich quick solution. I hope to get better than average returns over the long term but there are no guarantees. My program does complement my investing style but I could still invest without it. The first thing you must do is to decide how you want to invest.
I will tell you, more or less, what I do and you can make up your own mind about how you want to invest.
1) I hold a set of diversified funds with good long term track records.
2) I review the funds once a month against other investing opportunities to get a feel for whether the various trends, that each fund is representing, are still valid.
3) I recycle the funds every 3 to 6 months if needed. I do not recycle in a shorter time frame than 3 months. Even if your monthly review suggests a changing trend, do not be tempted to switch out in less than 3 months. You must allow a fund some time to reflect its long term trend.
4) I check my returns against known benchmarks such as the FTSE100 and S&P500.
5) Get a projection of how much pension income you expect to get in today’s terms. This will give you some realistic expectations and may inspire you to save more each month.
6) Read some books. I would suggest
“Hot Commodities” by Jim Rogers
- Then choose a good commodities fund as a core holding. Do NOT be tempted to play the commodities market, or use any kind of leveraged product, or you will lose all your money.
“First Time Investor” By Larry Chambers
- The guy is obviously a firm EMT believer but this is very useful as a fundamental basis for investing.
” How to Pick Stocks Like Warren Buffet” By Timothy Vick
- Allows you to understand the importance of this style of investing. Try to find fund managers who use this style of investing for some of your diversified funds.
“Undercover Economics” By Tim Harding
- A good read – everyone should read it :-).
7) Read the financial papers regularly - look for long term up trends and interesting sectors.
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Aw shucks, thanks Robin. That’s what I try and do, though the success of the blog depends on the people who comment because the best pages by far are the ones with screeds of debate. I’m not brilliant enough to do the wonderful world of investment justice, however hard I try! There’s just too many questions and too many answers…
Looking at your ’system’ (I’m fascinated by them) there’s one big thing I’d like to know, and that’s what goes through your mind when you are in stages 2) and 3)? i.e. why would be grounds for ditching one fund, and picking up another.
Sorry, bit late here but I just wanted to reply to Colin and Simon (above).
Colin - thanks for explaining the mechanism by which house prices could impact the wider economy and thereby the stockmarket. I think it would be interesting to establish to what extent that’s happened before. An email correspondent, Nigel Taylor, reckons it hasn’t - or at least he can’t find evidence of a houseprices being correlated to stockmarkets. So that’s the challenge.
Simon, you’re an optimist, so am I. Good to have you aboard
Hi Richard,
This is not a simple question to answer as my program allows me to do this at a very complex level.
However, put very simply, I would do the following
1) Work out a benchmark index (i.e. an index I am not likely to be able to do better than over the long term). If doing this by hand I would probably work out the average performance of the FTSE100, DJ, SP500 and HSI over 1, 3 and 6 months).
2) If my portfolio was lagging behind this average I would look at my individual fund choices and see which was dragging the performance down. This would be my indicator to make a switch (to either another fund in the sector or a different sector entirely).
In a global bear market I would be looking at property, bonds, cash, commodities and total return funds. I would select a combination to keep me well ahead of my equity index.
Robin, fascinating. We’re exact opposites! You’re a momentum investor and market timer. I don’t follow trends and therefore have no need to time the market. Yet here we are agreeing about so much! It just confirms my view that there are as many ways to make money in the stockmarket as there are (successful) investors.
Thanks Richard.
Incidentally I lost money last month (relative to the market) and you are correct it concerns me greatly when I do.
I agree our trading strategies are very different, but market timer sounds so ‘dirty’
Anyway, I would challenge anyone who said they could do fundamental analysis on funds! These are inherently mathematical objects and fundamentally (‘scuse the pun) different from companies.
I have found getting good advice on actual fund quality to be extremely difficult. I provide a couple of recent quotes from the financial press which might illustrate the point [note the editions were not in the original text]
Andrew Pitts (Editor of Money Observer) advising some poor reader on why their Japan fund lost so much money (after Money Observer recommended the fund a year earlier):
“All Japan funds lost money in 2006 [ed – yep, but your recommendation lost more than any other] Most Japan watchers expect the markets to recover [ed - yeah right] … You need to be confident that Hideo Shiozumi [ed – who?] can restore the funds fortunes, otherwise you should consider switching to another Japan fund [ed – how about another sector matey!]”
Mark Dampier (Spin-doctor for Hargreaves Lansdown and contrarian) on selecting his best income portfolio:
“Dampier had considerable trouble diversifying [ed – oh come on!]… he explained “The truth of the matter is that all asset classes have had a fantastic 10 years or so[ed – 4 years perhaps]. The poorest of them has been equities which is why my portfolio is so equity orientated [ed – why exactly?]…. but the important fact to bear in mind is that you are getting jam tomorrow rather than today [ed – eh???]”
Conclusion:
I would rather rely on statistics as they can tell a more honest story (Black Swans or no Black Swans).
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Hi Robin, your observations on financial punditry were so interesting I’ve started a whole new post (see the link above ‘Experts with the ‘X’ factor). In general, I’m in agreement. Regarding fundamental analysis of funds, I don’t know that it is impossible. I haven’t tried it myself but I did once interview John Chatfeild-Roberts, who manages the Jupiter Merlin funds. He wrote a book called ‘Fundology’, which among other things discussed how to pick funds. One of his suggestions, I remember because at the time it struck me as a good idea, was that investors ring the fund manager and ask it for the price earnings ratio of the fund. They should be able to tell you, he said, and if they can’t that might tell you something too! Here’s the interview. Anyway good luck with the stats
Hi Richard,
I was going to write a very brief reply but ended up writing another long one.
I refer back, in spirit, to one of your own articles
http://blog.iii.co.uk/?p=54
Anyway, if I could access the P/E ratio of all the funds then I would use it in my program as a way of breaking the tie between two otherwise equal funds.
What I would really like are:
1) The fund PE ratio (which I assume is calculated as an average)
2) The current spread of underlying PE ratios (e.g. as a standard deviation)
3) A measure of how these numbers varied over the last 6 months.
4) The range of long term min and max PE ratios for the sector
I could make use of this data quite effectively.
However, my program tries to track trends so it does not really care if value investing is best.
All it cares about is whether value investing is best right now (see p=54)
Other data which would be of interest would be
- Performance relative to other funds in sector
- Star ratings
- Churn rate of the underlying portfolio
- Sector and region breakdowns
- Is the fund ‘team based’ or ‘Star Manager’ based?
- Manager moves
- Sector Forecasts - could be useful as a future momentum indicator
With this type of data I could pick up new trends more quickly and not have to rely on long and short term moving averages so much.
Of course it is all rear-view mirror stuff (and ‘market timing’ to use a dirty word) but it is amazing how different themes can stay around for months.
PS If iii want to sponsor an investigation to see if the algorithm can actually work in the long term, by providing the relevant fund data, then I will be more than happy to oblige
Hi Robin,
Oh yes I stand by that article in that sometimes as a group value shares beat growth shares and vica versa. But the price earnings ratio can be used to identify growth shares as well as value shares (ie. high pe indicates expectations for earnings growth), so I don’t think it ceases to be useful in a period of supremacy for growth. Also, even if the market is likely to favour growth shares as a group, it doesn’t mean there are no bargains out there. I appreciate this is harder to do with funds - you’d need to ring a lot of managers! Which brings me to your shopping list…
To be honest I don’t even know if half of it exists! Some is available in the fund fact sheets on the main Interactive Investor site though. For example, fund ratings, performance against sector, and sector weightings, as you can see in this example for Marlborough Special Situations. Beyond that, I’ll make some enquiries, but don’t hold your breath!
After a brief exchange of emails with our resident funds gurus I’ve also discovered the manager’s name in the fact sheet links to the funds he’s managed and his start and end dates. Also regional info exists where it’s relevant. So, not the whole list, but most of it. Though not in the format you’d need if you were to do your own number crunching with it.
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