In my time as a financial professional, I have seen many downturns, some more significant than others. I started work in this world of finance in May 1988 and since then these are the ones that have stuck in my head:

1990 Recession (Personally very painful - anyone with a mortgage at that time will never forget it!)

1997 Asian Banking Crisis (Debt, too much of it)

1998 Collapse of Long-Term Capital Management (Overconfidence)

2000 Dot-com Crash (Some stuff way too expensive)

2008 Banking Crisis (These happen periodically and will again)

2012 Grexit (Should have happened, but didn’t)

2016 Brexit (Should not have happened. Mostly felt in currency so far)

2020 Covid-19 (We could add oil to this and a recession - possibly)

Problems, obstacles, disasters, however we want to call them, they always happen and always will do. They are so difficult to predict in advance. As an investor, you should always expect a significant event every three or four years. Is this Covid-19 significant yet? Will it become more significant? I don’t know.

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So, from an investment perspective, what should we do now?

Nothing. For now, we say you should do nothing. Why? We cannot predict the future. We can only tell you what we know today and what happened yesterday. We cannot tell you much about tomorrow, other than it will come. We don’t know tomorrow’s price for anything!

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Are you retired, or about to retire?

What we will have done already, is to make sure that if you need an income in retirement, either now or soon, don’t worry. Our portfolios hold short-dated bonds (this is typically money lent to high quality governments). These are the defensive assets and they will now be appreciating in value. While ‘investors look for a safe haven’ as the media likes to describe it, you’ve already got it built in.

During the banking crisis of 08-09 (the biggest event of those listed above, so far), these short-dated bonds enabled our clients to:

1. Draw money in retirement without touching any real assets (shares and property).

2. And when stock markets got very cheap (March 2009), we were able to sell some of these bonds and buy more shares at bargain prices.

Put simply, if you are due to retire in the next few years, or you are already retired; by holding an investment portfolio that contains these short-dated bonds within it as defensive asset; you should be fine. But if you are not sure please give us a call, we welcome it. 

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Are you saving for the long term?

I think the answer is in the question. Long term, equity markets have delivered great returns. If your investment time horizon is 10, 20, 30 years or more. Don’t worry. All the events I mentioned before end up looking like mere blips when you look backwards. I am 54 now (ouch) and the 1990 recession was horrible at the time, but looking at it now:

If I invested £1,000 in the FTSE All Share in 1988 (when I started work in finance), by the end of 2018 it would be worth £11,882 (30 years on).

If I waited until the 1991 to make the same investment, and thus avoid the market downturn on news of a recession that will occur in the future (market fell 17% in 1990), I would now be sitting on £9,049

Source: Dimensional Fund Advisers Matrix Book 2019

So, keep investing regularly and ignore the short-term noise. Don’t turn yourself into a short-term investor if you have a long-term investment horizon.

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But there is one big difference!

All the other falls had nothing to do with your health, or the wellbeing of your family, friends and other loved ones. Follow the Government advice and we hope everyone stays safe and well.

It seems logical to believe that the performance of a country's stock market is linked to the state of its economy. After all, if GDP growth is strong, company profits are good, and that should help share prices.

Economic prospects are even often used to identify which stock markets are likely to perform in future. If a country is experiencing positive GDP growth, then investors are encouraged to see it as a good place to put their money.

What the evidence reveals

Yet several studies have shown that this link is actually weak. A comprehensive analysis of 21 countries over more than 100 years by the authors of the book Triumph of the Optimists found mixed results between GDP growth and stock market performance.

An MSCI analysis in 2010 found similar results. Most notably, for the 60 year period from 1958 to 2008, Spain and Belgium enjoyed real growth in their economies of between 3% and 4% per year, yet the real returns from their stock markets over this same time were negative.

One of the clearest examples of the potential breakdown between a country's economic performance and that of its stock market has been Japan. Since 1989 the country has grown its economy at over 1.5% per year, yet the Nikkei 225 Index is still well below its December 1989 peak. That is a period of more than 30 years in which Japan's GDP growth has not been reflected in broad market returns.

A closer look

This doesn't only occur over the long term either. It can also be play out from year to year.

The tables below, which consider the last 90 years of GDP growth in the US, make this clear. On the left are the 15 calendar years during this period in which US growth was weakest, and on the right are the 15 years in which it was strongest.

What stands out is that in more than half of the worst years, returns from the stock market were still positive. In six of them, the S&P 500 was up more than 20%, even though GDP growth was zero, or negative.

Not quite as striking, but nevertheless noteworthy, is that even in some of the best years for the US economy, the stock market fell. Incredibly, in 1941, when GDP growth was 17.7%, the S&P 500 declined 12.8%.

Understanding the gap

It is clear from these studies that the state of a country's economy should not be seen as a guide for how its stock market is likely to perform. As MSCI notes, there are three main reasons for this.

“First, in today’s integrated world we need to look at global rather than local markets. Second, a significant part of economic growth comes from new enterprises and not the high growth of existing ones; this leads to a dilution of GDP growth before it reaches shareholders. Lastly, expected economic growth may be built into the prices and thus reduce future realized returns.”

Investors should therefore be cautious about basing their decisions on economic data. This has even been apparent in the UK over the past five years.

The story in London

Since 2014, the local economy has mostly staggered along at growth rates below 2%. Yet, the FTSE All Share Index has delivered an annualised return of 9.4%, which in today's low inflation environment is a real return of close to 8%.

If an investor had stayed out of the market due to fears around Brexit and the country's general lack of economic momentum, they would have missed out on this period of growth.

Similarly, those who argue that the US stock market is going to continue to show good returns almost always base their argument at least in part on the fact that the US economy is still strong. As history is shown in the case of Japan, however, a growing economy does not necessarily equate to good returns for investors on the stock market, particularly if share prices are already high.

Trying to guess which markets may or may not deliver the best returns in future based on the economic prospects of the country in which they are based is therefore not a way to investing success. Investors are far better off building a strategy diversified across markets that they can stick to no matter the economic environment, and reap the rewards over the long term.

Photo by Vlad Busuioc on Unsplash

This year marks the 300th anniversary of one of the world's most famous financial catastrophes: the South Sea Bubble. It is a story with complex origins, but the pattern of events in 1720 has unfortunately been repeated in similar ways many times since.

It is not necessary to know all the details to appreciate what happened in London three centuries ago. However, it is worthwhile to look at how ordinary people were drawn into mistakes that left many of them ruined.

Money from nothing

At the start of 1720, stock in the South Sea Company was changing hands at £128 per share. The company was only moderately profitable, and the trade it ran between Britain and South America was small.

Its directors, however, were full of stories about how the riches of that continent were ready to be brought to Europe. Since the South Sea Company did have exclusive rights to provide the Spanish colonies with slaves, and to send one trading ship to the continent per year, these stories did have a kernel of credibility. They were, however, easily inflated.

The South Sea Company's main business had always, in fact, been supporting the British national debt. Since 1711 it had provided millions of pounds in funding to the government by selling its own shares.

It had become so important to the state that King George I was appointed as the company's governor in 1718. In 1719 it agreed to restructure more than half of the national debt in a way that would reduce the government's interest payments.

Growing interest

This gave the company room to issue even more shares on the public market. To make them more attractive, the directors not only pushed the idea that its South American trade was set to take off, but also came up with a scheme that allowed investors to buy these shares in instalments rather than having to pay the full price upfront.

This made them available to many more people, a lot of whom had no real idea what they were buying. They were however seduced by the rising share price and the tales of South American wealth.

By February, shares had climbed to £175, and in March they reached £330. May took the stock to £550.

Not wanting to miss out on this opportunity, more people bought more shares, and the price went up further. In August, the stock was up almost ten times in just eight months, at over £1 000, and the euphoria was at its peak.

However, just as suddenly as it had began, the bottom fell out of the market. At the price being asked, there were simply no more buyers.

Within months, demand for the shares collapsed. By December, the company's shares had slumped back to £124 and many people had lost huge amounts of money.

Repeating history

The lesson most often associated with this series of events is that investors should be wary of anything that becomes a 'sure thing' in popular opinion. Almost everybody was certain that shares in the South Sea Company were only going to keep going up, and the rapidly rising price appeared to confirm their view.

The danger is that when this kind of thinking takes hold, it does become a self-fulfilling prophecy for a while. The price of South Sea Company shares kept going up because people kept buying them. However, at some point the limit of buyers will be reached, and from there the crash back down can be brutal.

The more subtle lesson, however, is that most of the ordinary investors who were buying the company's stock did not know or understand what they were buying. Not only was trade in shares still novel to them, but they did they not appreciate that the South Sea Company's shipping operations were not its main focus. They also had no idea of the complexities involved in its relationship with the British government.

A recent Bloomberg article noted how more and more ordinary investors today are buying complex financial products that have become available to them due to technology. These include forex, leveraged exchange-traded products and cryptocurrencies.

These products are not necessarily going to create bubbles, but they do seem 'sexy' because they can make rapid gains. This, however, is exactly what makes them dangerous. Anything that can go up quickly can can down just as quickly, and these sudden price movements can be devastating.

The South Sea Bubble should stand as a reminder that successful investing is not about chasing the most exciting opportunities. It is actually the opposite: be boring. Diversify, keep your costs down, and let the market do its work over time.

Photo by Annie Spratt on Unsplash

It’s not mentioned often enough in the financial media that many of the keys to success as a long-term investor derive from qualities that are distinctly out of tune with the times. These include patience, discipline and crucially, delayed gratification — a readiness to prioritise distant rewards over instant ones.

In fact, the times we’re living in are almost antithetical to long-term investment. We are overwhelmed by choice. We are told we can have everything we want right now. And, if we can’t afford it, we can put it all on the plastic and worry about paying for it later.

All gain-no pain has a ready market 

The fact is there’s a ready market for the notion of all gain-no pain. Witness the dieting magazines that promise their subscribers perfect bodies with little expense or effort other than the cover price and sticking reminder listicles on the refrigerator door.

It works similarly in the investment world. Much of the financial services industry, and the media that serves it, wants people to believe in the idea that investment returns come down to “hot tips” and easy shortcuts. The giveaway pitch is “high returns with low risk”.

A dissenting view about the instant gratification, you-can-have-it-all-right-now economy has been memorably expressed by Charlie Munger, the business partner of legendary investor Warren Buffett and a man known for turning conventional wisdom on its head.

We can’t stand to wait

“Waiting helps you as an investor and a lot of people just can’t stand to wait,” Munger once said. “If you didn’t get the deferred-gratification gene, you’ve got to work very hard to overcome that.” 

Perhaps it’s due to the nature of modern consumer capitalism, which runs on encouraging people to pursue an endless and unquenchable cycle of externally generated desires. In other words, the notion of delayed gratification is out of tune with the times we live in.

But the ability to forgo today’s desires for the prospect of longer-term fulfilment is one of the most elemental requirements for success as an investor. Buffeted by media noise and the lure of short-term returns, we have to be able to resist the temptation to tinker.

Again, as Munger put it: “People are trying to be smart. All I am trying to do is not to be idiotic, but it’s harder than most people think.” 

One in five don’t plan for the long term at all

Just how hard it is was highlighted in a recent report by the UK online wealth management firm MoneyFarm, which looked at why as a society we seem to find it so difficult to invest in our future wellbeing and are so easily distracted by short-term temptations.

The research found that 21% of Britons don’t plan for their long-term future at all. And a further quarter (25%) think less than six months ahead. Five years was the furthest that most people (29%) currently plan for.

The causes of this short-termism are many, the report says, including a surfeit of choices and a subconscious view that by opting for one we limit our own freedom. Another factor is that thinking about our long-term future creates anxiety, which we treat with instant consumption.

How do we deal with it? The report recommends a number of strategies, such as imagining the most positive outcome from a change in our financial behaviour and consciously thinking about the biggest obstacles to our getting there.

Social support is important

Another underrated technique is galvanising social support around our goals from friends, family and professional advisers. The need, as Munger says, to wait patiently, to not do stupid things and to stay focused on a long-term goal is hard to do alone.

But the first step is setting the goal and building a plan to achieve it.

You can download the full MoneyFarm report here.

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