Is the stock market ripe for a fall?

Written by multiforte on . Posted in News

The world is an uncertain place. Yet, as humans, we crave certainty. So it’s no surprise that, as media speculation on a stock market fall becomes louder, we are drawn to the opinions of those who provide us with certainty.

In finance, the more certain an investment expert or commentator is, the more likely it is that individuals will believe in what they’re hearing as though it’s guaranteed.

Right now, there is an investment manager somewhere in the market who will become lauded for their foresight at some point in the coming years.  When the next bear market occurs, this person will have demonstrated spectacular performance. He or she will have most likely taken a conservative position with a large cash allocation in the months before the market nose dives.

US-based advisor, James Osborne argues that the impact of performance on a lucky timing call cannot be overstated.  He tells the story of US investment manager, John Hussman, through the financial crisis.

“In 2007 Hussman was up 4.16%, just under the 5.49% return of the S&P 500. In 2008 the S&P 500 fell -37.00%. And Hussman? He lost only -9.02%.  He was nearly 28% ahead of the benchmark in one of the worst bear markets in 75 years. From the fund’s inception in mid-2000 through to 31 December 2009 the Hussman Strategic Growth Fund returned 8.19% annualised.  Pretty amazing numbers, considering the S&P 500 return was close to 0% over that same time period.”

Investors, excited by the prospect of improved performance from the new guru flooded into Hussman’s fund after he dodged the 2008 bullet.  The fund’s assets doubled in size in two years: from US$3 billion in 2008 to US$6 billion in 2010.

Unfortunately, says Osborne, Hussman’s golden touch was not to last. “The fund has imploded since 2009. It lost money in 4 of the last 5 full calendar years while the S&P 500 has been on a historic bull run.  As always, investors have fled and the fund’s assets are now about $800 million. The fund’s 10-year trailing performance is a cringeworthy -2.46% (to 31 March 2015), compared to 8.01% annualised gains from the S&P 500. To put that another way, S&P 500 index fund investors have doubled their money, and Hussman investors are down about 30%.”

And here we are in May 2015, and it is highly likely that this scenario is going to repeat.  There will be another investment manager who makes a lucky bet and comes out of the next bear market looking like a guru. The performance of the fund from the bottom of the bear market will significantly outperform the index. They will be acclaimed for their skill in navigating financial markets and investors will flock to them in droves.

And, again, investors are going to get burnt.

So what can you do when faced with uncertain stock markets?

Let me start by putting our cards fairly on the table. We do not know how long the stock market will continue to deliver the level of strong positive returns we have seen in the past 12 months. We do not know when it will go down. We do not know if it will crash.

We do know that markets do tend to revert to the mean. Aside from the long-run positive returns of the stock market, streaks of excessively high stock market returns do not persist – they are typically followed by lower future returns (possibly even negative returns). Similarly, the laws of financial gravity also operate in reverse. For the stock market as a whole, what goes down eventually comes back up.

So what can you do? Here are our recommendations.

  • You can continue to invest in line with your long term plan.
  • You can recall that risk plays an important role in the stock market. There is always a risk – and that’s what makes it so rewarding.
  • You can also recall that there is always a risk in not investing.
  • You can remind yourself that there is a long term uptrend in the stock market, it can be very risky to be in cash. An investor who frequently carries a large cash position to avoid periods of market decline is very likely to be out of the market during some periods where it rallies substantially. Research has shown investors pay a terrible price for missing the market’s best days.
  • You can, if you feel uncomfortable and unable to easily sleep at night, review the level of investment risk in your portfolio to help soften a potential fall.

And as always, if you would like to discuss your investments or level of risk with us, please call or email. We are sure we can help you achieve a good outcome.

Sources: James Osborne, Bason Asset Management, 29 April 2015