Posts tagged stock market
Coronavirus Briefing

I cannot tell you how bad things will get in the future for this virus or tell you how much it will affect your investments. My advice as always is to simply sit tight. If it gets really cheap, there is a potential opportunity and we will advise accordingly.

I have produced a table below to show how world equity markets have performed in recent epidemic scares.


MSCI World Index: World epidemics and global stock market performance.

Source: Charles Schwab, Fact-set data for 1,2&3 month performance. Dimensional Matrix Book 2019 for That year and 1 year later. The MSCI Index captures large and mid-cap representation across 23 developed markets countries. With 1,646 constituen…

Source: Charles Schwab, Fact-set data for 1,2&3 month performance. Dimensional Matrix Book 2019 for That year and 1 year later. The MSCI Index captures large and mid-cap representation across 23 developed markets countries. With 1,646 constituents, the index covers approximately 85% of the free float-adjusted market capitalisation in each country.


So how should we approach the news about COVID-19, better known as the coronavirus. We know that human beings are finely attuned to what we see as an immediate threat. It’s how we evolved. But it isn’t always helpful.


What about the impact on your investment portfolio?

Stock markets fell heavily in the last few days and there’s no shortage of market “experts” in the media warning of further “turmoil” to come.

But the simple fact is that they just don’t know. Yes, coronavirus could develop into a global pandemic. Or it could blow over in a matter of months. In any event, predicting what impact all the different possible eventualities might have on the economy, let alone the financial markets, is nigh on impossible.


Focus on what you can control

A very important principle in investing is to focus on what you can control and let the rest go.

You have no control over coronavirus or the markets. Unless you’re a professor of epidemiology, don’t kid yourself either that you have any unique insight into how the virus might develop. And remember markets could go sharply up or down from where they are now for reasons totally unrelated to COVID-19.

But, if you’re anxious about the markets — and it’s a natural human reaction to be so — please feel free to give us a call.


If history teaches us anything, it’s that great investment gains go to those who are diversified, optimistic and patient. In other words, if you spread your investment bets widely, favour stocks and have a long-time horizon, good things should eventually happen.
Don't base your investment decisions on the economy

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.

Economics.png

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

Why it's so difficult to be a stock picker

In a recent research paper entitled 'How to increase the odds of owning the few stocks that drive returns', global asset manager Vanguard revealed a telling statistic. Between 1987 and 2017 just under half of the 3 000 largest stocks listed in the US delivered a negative return.

Over this 31 year period, 47.4% of companies in the Russell 3000 Index saw their share prices decline. Some of those went bankrupt, delivering a negative 100% return.

What's more, the return of the median stock over these three decades was just 7%. In other words, if you picked the average stock, your return was insignificant.

This was over a period when the total return from the Russell 3000 Index was 2 100%. As the chart below illustrates, this performance was driven entirely by just 7.3% of stocks that returned over 1 000%.

Pie chart.png

Source: Vanguard, Wealth Logic LLC

Needles in the haystack

Of course, this is something of an over-simplification. Just because a stock declined over a full 31 year period, doesn't mean that it didn't make significant gains in between.

For instance, Superdry's share price may be 80% down from its 2018 peak, but an investor who bought the stock in mid-2012 and sold out of it before it collapsed could still have earned a return of 700% or more. It was, therefore, still possible to make a big return, even though Superdry's performance since listing is ultimately negative.

However, the broad lesson holds: there is an extremely small pool of persistent winners in the stock market. An investor picking a share at random is far more likely to under-perform the market over the long term than to out-perform it, and has almost a 50% chance of losing money.

This illustrates how difficult it is to be a successful stock picker. There are very few companies that are going to deliver a long term out-performance. It may be possible to beat the market through buying and selling stocks like Superdry at the right time, but that comes with additional risk. If you get it wrong, the consequences can be severe.

Fewer needles, more haystack

Research from the National Bureau of Economic Research (NBER) in the USA also suggests that not only are the 'winning' companies rare, but they are becoming even more so. A 2016 paper entitled 'Is the U.S, public corporation in trouble?' found that, on average, listed companies in the US have become larger, but they have also become less profitable.

Profitability is one of the key factors in share price returns, as investors are effectively buying a share of the company's future earnings. The higher those earnings are likely to be, the more investors will be willing to pay.

What the NBER found, however, is that the profitability of the market as a whole is being driven by a smaller and smaller concentration of companies.

“Over the last 40 years, there has been a dramatic increase in the concentration of the profits and assets of US firms,” the NBER authors note. “In 1975, 50% of the total earnings of public firms is earned by the 109 top earning firms; by 2015, the top 30 firms earn 50% of the total earnings of the U.S. public firms. Even more striking … we find that the earnings of the top 200 firms by earnings exceed the earnings of all listed firms combined in 2015, which means that the combined earnings of the firms not in the top 200 are negative.”

The growing concentration of not just earnings, but many measures of corporate strength among listed companies is illustrated in the table below:

Concentration.png

Source: National Bureau of Economic Research

Compare this against the table below, which shows how, on average, profitability has fallen significantly over this 40 year period:

Profitability.png

Source: National Bureau of Economic Research

What are your chances?

“Though performance has worsened for the average firm, the winners have done very well,” the study points out. “One way to see this is that four new firms entered the list of the top five firms by market capitalization in 2015, relative to 1995. Specifically, Apple, Google, Microsoft, and Amazon replace AT&T, Coca Cola, General Electric, and Merck. In 2015, these four firms combined had earnings of $82.3 billion, representing 10 percent of the earnings of all public firms combined.”

This shows just how small the pool of 'winning' stocks has become. Successfully identifying them beforehand would be extremely profitable, but it is also becoming more and more difficult to do.

Photo by Chris Liverani on Unsplash