The truth about equity markets is slowly emerging. Of course, it’s been there for a long time for anyone bothered to look, but too many vested interests act to obscure sometimes harsh reality. Historically, equities are the best performing asset class, globally, but the availability of those returns to investors is a moveable feast. And the sense in which equities are a “sure thing” is a very slippery concept.
The real picture has been painted steadily and surely in the annual publication of the Global Investment Returns Yearbook , authored by Profs Dimson, Marsh and Staunton of the London Business School, sponsored by Credit Suisse. The authors demonstrate that while it is true that stocks are a fabulous investment over the long run, the timescale involved can be very surprising.
Virtually all fund managers urge their clients to think long term. Some say that the right time horizon for equities is three to five years. While that might be correct in one or two circumstances, it is almost always too short. The best performing equity market in history has been the US, but even there, it has been possible to lose money over a 16-year period.
All other countries have had losing runs for stocks that have been longer, sometimes amazingly so. An examination of stock market history reveals that the long run is very long indeed.
Sensible strategy
Investing in high-growth economies is often a sensible strategy, but the subtle sub- text is that this only works if the markets have not already priced this in: growth has to come as a surprise. What many investors end up doing is buying equities in countries that have grown surprisingly rapidly in the past. They are then often disappointed by what happens next: growth continues but stocks have already figured this out, or growth disappoints, in which case markets usually fall. The recent problems in many emerging markets are a case in point.
The lessons from all of this set up profound difficulties for savers of all kinds, not least pension funds. One reason why so many funds are in trouble – assets are worth a lot less than liabilities – is that the operators of those funds have not understood the nature of their investments. The truth about equities was ignored. Asset allocation, the most important decision for any fund, is sometimes perverse.
Not all funds have problems. Trouble has come in a variety of ways, sometimes just through bad luck, but some people forgot the basic rules of investing and paid a very heavy price; the consequences, for pensioners, are sometimes awful.
Investing is a difficult and very long-term game. It is is easy to say that the right time to buy equities – or any asset – is when they are cheap, but markets do give us those opportunities. At worst, never buy anything for more than it is worth. It seems to be a fundamental law of human nature that we find all of this next to impossible to put into practice. In March 2009, when the US equity market was roughly a third of its current level, it was tough to persuade anyone to put money into stocks.
Forecasters who purport to know where markets are heading over the next few years should be ignored. Anyone who successfully trades (as opposed to investing in) equities is exploiting an information edge, perhaps perfectly legally but always in a socially useless fashion. High-frequency trading is within the rules, for example, but don’t believe those involved when they say they are adding to the human condition.
Investing is all about creating the economic future and is a totally different ball game to the one that is too often played. From the Yearbooks we learn what proper investors have always known: equities are sometimes cheap, sometimes expensive. Buy them when they are cheap and you will almost always win – but over an extremely uncertain timescale. Buy them when they are expensive and you will lose, unless you are simply lucky.
