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Equity Markets and US Presidents

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When it comes down to the returns of stock markets under different Presidents – Democrat or Republican – does it really matter who is in power?  Should we change our portfolios?  Can we predict what is going to happen?  The quick answers are ‘no’, ‘no’ and ‘no’!

This is perhaps not really very surprising as the price of a company’s shares is based on the future cashflows that it will deliver discounted back to a present value, using a discount rate that reflects the risks associated with that company’s cashflows.  A Presidential term is four years, but a company’s cashflows run into the distant future.  Despite the partisan nature of US politics at this time, Democrats and Republicans are all still capitalists and believe in personal freedom, property rights and, yes – even if it does not feel like it at this moment – democracy.  In a broad political sense, Democrats and Republicans are simply variations on a democratic, capitalist theme.

Active fund managers may try to position portfolios to reflect world events, but predicting the future is very hard to do!  There was much talk of the ‘blue wave trade’ prior to the election to position for a Democrat clean sweep of all parts of government yet look how that seems to be turning out.  A few days ago, the prospect of a vaccine for Covid-19 sent airlines, banks and energy companies soaring and Zoom and other ‘lockdown’ benefiters, such as Ocado, down.

Random events and the release of new information moves the market’s view of cashflows and discount rates resulting in the movement of share prices.  Guessing against randomness is hard but taking on the known risk that equity returns are far less certain than holding cash, rewards investors who ignore this short-term noise and focus on the long-term.

The choice of the US President is important to some, but to the long-term investor it is largely irrelevant from an equity market perspective.

Coronavirus and Investing…

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The coronavirus is still very much with us, as is much of the economic dislocation occasioned by the resulting lockdowns.

Granted, we are evidently closing in rapidly on a vaccine, indeed, a number of vaccines.  However, it might be quite some time yet before most of us will get access to a vaccine, and frustration may abound. Furthermore, in the coming weeks we will have to go through a hyper-partisan presidential election in the US, with a variety of voting issues we’ve never had to deal with before.

So, before we’re further engulfed by these multiple unknowns, I want to take a moment to review what we as investors should have learned, or relearned, since the onset of the great market panic that began in February / March and ended when the 500 largest companies in the US, as measured by the S&P 500 Index, regained its pre-crisis highs in mid-August.

The lessons are:

    • No amount of study—of economic commentary and market forecasting—ever prepares us for really dramatic events, which always seem to come at us out of deep left field. Thus, trying to make investment strategy out of so-called “expert” forecasts — much less financial journalism—always sets investors up to fail. Instead, having a long-term Wealth Plan, and working that plan through all the fears (and fads) of an investing lifetime, tends to keep us on the straight and narrow, and helps us to avoid sudden emotional decisions;
    • The global equity market fell 26% in 25 days. None of us have ever seen such a speedy decline before, but with respect to its depth, it was just about average. When reviewing monthly returns data, this ranks 5th in the top declines dating back to 1970.  Declines of -49%, -35%, -33%, -29% have been experienced over that time period.  However, in those ~50 years to 30/09/2020, global equities enjoyed a cumulative return of 12,967% in nominal terms.  The lesson is that, at least historically, the declines haven’t lasted, and long-term progress has reasserted itself;
    • Almost as suddenly as global equities crashed, they completely recovered, surmounting its February 20 all-time high on September 2. Note that the news concerning the virus and the economy continued to be dreadful, even as the market came all the way back. I think there are actually two great lessons here:
    • The speed and trajectory of a major market recovery very often mirror the violence and depth of the preceding decline; and
    • The equity market most often resumes its advance, and may even go into new high ground, considerably before the economic picture clears. If we wait to invest before we see unambiguously favourable economic trends, history tells us that we may have missed a very significant part of the market advance.
    • The overarching lesson of this year’s swift decline and rapid recovery is, of course, that the market can’t be timed, that the long-term, goal-focused equity investor is best advised to just sit tight.

These are the investment policies you and I have been following all along, and if anything, our experience this year has validated this approach even further.

A word now, really just a repetition of what we’ve stressed before, about the US election.  Simply stated, it’s unwise in the extreme to exit global equities in which you’ve been invested during your lifetime because of the uncertainties surrounding the election.  Your chances of getting out the market and then back in advantageously are historically very poor, nor can Wells Gibson possibly help you in attempting to do so.

As we do before every UK or US election, we urge you to just stay the course.  As always, we’re here to talk through these issues with you.


Header photo by Sebastien Gabriel on Unsplash
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.

Key Questions for the Long-Term Investor

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Key Questions for the Long-Term Investor

Focusing on what you can control can lead to a better investment experience.

Whether you’ve been investing for decades or are just getting started, at some point it is likely you will ask yourself some of the questions below.  Trying to answer these questions may be intimidating, but please be assured you’re not alone.  Your financial planner or advisor should be there to help.  While this is not intended to be an exhaustive list, it will hopefully shed light on a few key principles, using data and reasoning, that might help improve investors’ odds of investment success over the long term.

  1. What sort of competition do I face as an investor?

The market is an effective information-processing machine.  Millions of market participants buy and sell securities every day and the real-time information they bring helps set prices.  This means competition is stiff and trying to outguess market prices is difficult for anyone, even professional money managers (see question 2 for more on this).  This is good news for investors though as rather than basing an investment strategy on trying to find securities that are priced “incorrectly,” investors can instead rely on the information in market prices to help build their portfolios (see question 5 for more on this).Picture1

* Year-end WM/Reuter’s London Close FX rates used to convert original US dollars data to British pound sterling.  Source: World Federation of Exchanges members, affiliates, correspondents, and non-members. Trade data from the global electronic order book. Daily averages were computed using year-to-date totals as of December 31, 2016, divided by 250 as an approximate number of annual trading days.

  1. What are my chances of picking an investment fund that survives and outperforms?

Flip a coin and your odds of getting heads or tails are 50/50.  Historically, the odds of selecting an investment fund that was still around 15 years later are about the same.  Regarding outperformance, the odds are worse. The market’s pricing power works against fund managers who try to outperform through stock picking or market timing and one needn’t look further than real-world results to see this.  Based on research, only 17% of US equity mutual funds and 18% of US fixed income mutual funds have survived and outperformed their benchmarks over the past 15 years.

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Source: Mutual Fund Landscape 2017, Dimensional Fund Advisors. See Appendix for important details on the study.  Past performance is no guarantee of future results.

  1. If I choose a fund because of strong past performance, does that mean it will do well in the future?

Some investors select mutual funds based on past returns however research shows that most funds in the top quartile (25%) of previous five-year returns did not maintain a top-quartile ranking in the following year. In other words, past performance offers little insight into a fund’s future returns.

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Source: Mutual Fund Landscape 2017, Dimensional Fund Advisors. See Appendix for important details on the study.  Past performance is no guarantee of future results.

  1. Do I have to outsmart the market to be a successful investor?

Financial markets have rewarded long-term investors. People expect a positive return on the capital they invest and historically, the lower-risk bond markets and higher-risk equity markets have provided growth of wealth that has more than offset inflation.  Instead of fighting markets, let them work for you.

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In British pound sterling. UK Small Cap is the Dimensional UK Small Cap Index. UK Marketwide Value is the Dimensional UK Marketwide Value Index. UK Market is the Dimensional UK Market Index. UK Treasury Bills are UK One-Month Treasury Bills. UK Inflation is the UK Retail Price Index. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio. See appendix for index descriptions.  Past performance is no guarantee of future results. The graph is for illustrative purposes only, figures presented are hypothetical and not indicative of any investment.

  1. Is there a better way to build a portfolio?

Academic research has identified these equity and fixed income dimensions, which point to differences in expected returns among securities. Instead of attempting to outguess market prices, investors can instead pursue higher expected returns by structuring their portfolio around these dimensions.

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Relative price is measured by the price-to-book ratio; value stocks are those with lower price-to-book ratios. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book.

  1. Is international investing for me?

Diversification helps reduce risks that have no expected return, but diversifying only within your home market may not be enough. Instead, global diversification can broaden your investment opportunity set. By holding a globally diversified portfolio, investors are well positioned to seek returns wherever they occur.

Picture5Number of holdings and countries for MSCI United Kingdom Investable Market Index (IMI) and MSCI ACWI (All Country World Index) Investable Market Index (IMI) as at 31 December 2016. MSCI data © MSCI 2017, all rights reserved. Indices are not available for direct investment.  International investing involves special risks such as currency fluctuation and political instability. Investing in emerging markets may accentuate these risks. Diversification neither assures a profit nor guarantees against loss in a declining market.

  1. Will making frequent changes to my portfolio help me achieve investment success?

It’s tough, if not impossible, to know which market segments will outperform from period to period. Accordingly, it’s better to avoid market timing calls and other unnecessary changes that can be costly. Allowing emotions or opinions about short-term market conditions to impact long-term investment decisions can lead to disappointing results.

Picture6In British pound sterling. UK Large and Mid-Cap is the MSCI United Kingdom Index (gross dividends). UK Total Market is the MSCI United Kingdom IMI Index (gross dividends). Developed Markets ex UK is the MSCI World ex UK Index (gross dividends). Emerging Markets is the MSCI Emerging Markets Index (gross dividends). Global Real Estate is the S&P Global REIT Index (gross dividends). UK Treasury Bills are UK One-Month Treasury Bills. WGBI 30-Year UK Hedged is the Citi World Government Bond Index UK 1–30+ years (hedged to GBP). WGBI Five-Year Hedged is Citi World Government Bond Index 1–5 Years (hedged to GBP). Global Fixed Income Hedged is Bloomberg Barclays Global Aggregate Bond Index (hedged to GBP). MSCI data © MSCI 2017, all rights reserved. S&P data provided by Standard & Poor’s Index Services Group. Prior to 1975: UK Three-Month Treasury Bills provided by the London Share Price Database; 1975–present: UK One-Month Treasury Bills provided by the Financial Times. Citi fixed income indices © 2017 by Citigroup. Data provided by Bloomberg. Indices are not available for direct investment. Index performance does not reflect the expenses associated with the management of an actual portfolio.  Past performance is no guarantee of future results.

  1. Should I make changes to my portfolio based on what I’m hearing in the news?

Daily market news and commentary can challenge your investment discipline. Some messages stir anxiety about the future, while others tempt you to chase the latest investment fad. If headlines are unsettling, consider the source and try to maintain a long-term perspective. Picture7

  1. So, what should I be doing?

Work closely with a financial adviser who can offer expertise and guidance to help you focus on actions that add value. Focusing on what you can control can lead to a better investment experience.

  • Create an investment plan to fit your needs and risk tolerance.
  • Structure a portfolio along the dimensions of expected returns.
  • Diversify globally.
  • Manage expenses, turnover, and taxes.
  • Stay disciplined through market dips and swings.

APPENDIX

Question 2: The sample includes US mutual funds at the beginning of the 15-year period ending December 31, 2016. Each fund is evaluated relative to the Morningstar benchmark assigned to the fund’s category at the start of the evaluation period. Surviving funds are those with return observations for every month of the sample period. Winner funds are those that survived and whose cumulative net return over the period exceeded that of their respective Morningstar category benchmark.

Question 3: At the end of each year, US mutual funds are sorted within their category based on their five-year total return. US mutual funds in the top quartile (25%) of returns are evaluated again in the following year based on one-year performance in order to determine the percentage of funds that maintained a top-quartile ranking. The analysis is repeated each year from 2007– 2016. The chart shows average persistence of top-quartile funds during the 10-year period.

Questions 2 and 3: US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Index funds and fund-of-funds are excluded from the sample. Equity fund sample includes the Morningstar historical categories: Diversified Emerging Markets, Europe Stock, Foreign Large Blend, Foreign Large Growth, Foreign Large Value, Foreign Small/Mid Blend, Foreign Small/Mid Growth, Foreign Small/Mid Value, Japan Stock, Large Blend, Large Growth, Large Value, Mid-Cap Blend, Mid-Cap Value, Miscellaneous Region, Pacific/Asia ex-Japan Stock, Small Blend, Small Growth, Small Value and World Stock. Fixed income fund sample includes the Morningstar historical categories: Corporate Bond, Inflation-Protected Bond, Intermediate Government, Intermediate-Term Bond, Muni California Intermediate, Muni National Intermediate, Muni National Short, Muni New York Intermediate, Muni Single State Short, Short Government, Short-Term Bond, Ultrashort Bond and World Bond. See Dimensional’s “Mutual Fund Landscape 2017” for more detail. Benchmark data provided by Bloomberg Barclays, MSCI, Russell, Citigroup and S&P. Bloomberg Barclays data provided by Bloomberg. MSCI data © MSCI 2017, all rights reserved. Frank Russell Company is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Citi fixed income indices © 2017 by Citigroup. The S&P data is provided by Standard & Poor’s Index Services Group.

Question 4: DIMENSIONAL UK SMALL CAP INDEX: January 1994–present: Compiled from Bloomberg securities data. Market capitalisation-weighted index of small company securities in the eligible markets excluding those with the lowest profitability and highest relative price within the small cap universe. Profitability is measured as operating income before depreciation and amortisation minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional Fund Advisors and did not exist prior to April 2008. The calculation methodology for the Dimensional UK Small Cap Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. July 1981–December 1993: Includes securities in the bottom 10% of market capitalisation, excluding the bottom 1%. Rebalanced semiannually. Prior to July 1981: Elroy Dimson and Paul Marsh, Hoare Govett Smaller Companies Index 2009, ABN-AMRO/Royal Bank of Scotland, January 2009.

DIMENSIONAL UK MARKETWIDE VALUE INDEX: January 1994–present: Compiled from Bloomberg securities data. The index consists of companies whose relative price is in the bottom 33% of their country’s companies after the exclusion of utilities and companies with either negative or missing relative price data. The index emphasises companies with smaller capitalisation, lower relative price and higher profitability. The index also excludes those companies with the lowest profitability and highest relative price within their country’s value universe. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional Fund Advisors and did not exist prior to April 2008. The calculation methodology for the Dimensional UK Value Index was amended in January 2014 to include direct profitability as a factor in selecting securities for inclusion in the index. Prior to January 1994: Source: Dimson, Elroy, Stevan Nagel and Garrett Quigley. 2003. “Capturing the value premium in the UK”, Financial Analysts Journal 2003, 59(6): 35–45. Created Returns, converted from GBP to USD using the WM/Reuters at 4 pm EST (closing spot), from PFPC exchange rate.

DIMENSIONAL UK MARKET INDEX: Compiled by Dimensional from Bloomberg securities data. Market capitalisation-weighted index of all securities in the United Kingdom. Exclusions: REITs and investment companies. The index has been retroactively calculated by Dimensional and did not exist prior to April 2008.

UK ONE-MONTH TREASURY BILLS: Provided by the Financial Times Limited. Prior to 1975: UK Three-Month Treasury Bills provided by the London Share Price Database.

UK RETAIL PRICE INDEX: Provided by the Office for National Statistics; Crown copyright material is reproduced with the permission of the Controller of HMSO.

Career Aspirations and Salary Estimates from Today’s Children

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What did you want to be when you grew up?

The aspirations of children today are likely very different from those of our childhoods.

According to the latest Pocket Money survey from Halifax, 19% of children today want to be a doctor or nurse when they grow up.

Jobs in the health service were a popular choice, with the incredible work of the NHS during the Covid-19 pandemic likely putting this career front of mind.

13% of children want to be a doctor, only slightly behind the aspiration of 14% of children to become a professional footballer.

6% dream of becoming a nurse and 5% want to become a paramedic.

Unsurprisingly, social media stardom was also a popular choice, with becoming an online influencer selected by 12% of children – the same number who said they want to become a teacher!

For boys, social media stardom was the second most desirable job, behind becoming a Premier League footballer.

Girls chose becoming an online influencer as their joint third most popular choice, alongside training to become a nurse.

The most popular career choice for girls was becoming a doctor, with becoming a teacher in second place.

Becoming a police officer was the preferred career choice for 9% of children, with 6% wanting to fight fires and only 3% dreaming of becoming the Prime Minister.

Nearly a third of children list the amount of money you can earn as one of the top reasons to pick a career. For boys, that figure rises to 39%, compared to 26% for girls.

Interestingly, girls are more likely than boys to select their dream job if doing so gives them the opportunity to help other people.

Making sure you have fun in your job, and providing for a future family, were popular choices for both genders.

21% of children said they are yet to think of their future job.

When asked to estimate their future earnings, the children wanting to become Premier League football players set their sights the highest. They estimated an annual wage of £4.7 million, up £1.3 million on the estimates given a year ago.

The next highest estimate salary came from children wanting to become Prime Minister, thinking they would earn £2.4 million a year – around 16 times the actual pay for the role.

Becoming a social media influencer comes with an estimated salary of £1.3 million a year, which might be pushing it a little – a recent survey found that most UK-based bloggers charge between £100 and £250 per post.

While kids’ estimates of salaries may seem over-inflated they seem to have an understanding of where money comes from.

When asked to think generally about the origins of people’s cash, two thirds understand that it is earned through work, and 42% think it’s provided by the banks.

The myth of the money tree is alive for just 2% of children who believe an arboreal bounty is out there somewhere.

Emma Abrahams, Head of Savings, Halifax, said:

“In a year that has seen the nation truly appreciate the heroic efforts of the NHS, it’s no wonder we are seeing many kids aspire to be a doctor or a nurse when they grow up

“And while others dream of social media stardom or being a football star it’s good to start conversations about money early, so little ones really appreciate the importance of earning the pound in your pocket.”

Brussels, Belgium, Header photo by Piron Guillaume on Unsplash

Not All US Shares have Gone Up in 2020

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“If the history of bubbles teaches us anything, it’s to be humble… Fama doesn’t think we can predict bubbles. Shiller thinks we can but doesn’t think we can ever know when they’ll collapse. What we need, but I know we’ll never get, is more of this type of thinking. I’m holding out for a humility bubble.”

[Fama and Shiller both received Nobel Prizes for economics for their diametrically opposed views on markets! – Ed.]
Morgan Housel – Author[1]

Well, 2020 has been a strange year so far for equity investors; the early gains of global equity markets in the first couple of months turned into material – and rapid falls – in all equity markets.  Yet, as we sit here in the early days of Autumn, global markets are more or less back where they were at the start of the year, although the UK is a laggard.  Thank goodness for diversification.  Across the pond, the US market has rebounded strongly and the tech shares such as Apple, Google, Amazon, and the electric vehicle firm Tesla have appeared to defy gravity.  Hands up all who wishes they owned more US tech shares.

Sometimes the disconnect between what is happening in the economy and what is happening on Wall Street is hard to reconcile in one’s mind.  However, we need to remember that the market looks beyond well beyond our current challenges and discounts all future earnings into prices.  To those who believe markets work, this represents the best guess of the value of a company today, given the information we have available to us.  To others it may feel like bubble territory and a big momentum play into a few companies getting lots of media attention and investor dollars.

We also need to remember that trading in the markets – buying Apple – is not as simple as saying that Apple is a good company, so the price should go up – but a process of estimating whether the market has over – or underpriced just how good Apple is.  Did Apple’s market value double from US $1 trillion in August 2018 to $2 trillion in August 2020 because the discounted earnings were expected to be far larger than the market thought, or are we in bubble territory?  If you are hoping for an answer, then you will be disappointed; no-one really knows.

If we look beyond these gravity-defying shares, we see that the returns from the vast majority of US companies is less than stellar, perhaps reflecting more closely how many feel about the current economic environment; in fact 335 shares in the S&P 500 sit below the market average for the year of around 12%.  Half of all shares have actually lost money, yet maybe some of them will be future winners. 

Fortunately, as systematic, long-term investors, clients of Wells Gibson have avoided the full brunt of the UK’s woes and picked up some of the benefits of owning US tech shares.  Could we have predicted this outcome?  Do we know what happens next with any certainty?  Let’s be honest, we don’t know, you don’t know and nor do any professional fund managers.

All we can really do is to remain well diversified, try to avoid the feelings of wishing we had more in the US tech shares, and be patient. Investing using the rear-view mirror is never advisable. If history tells us anything, it is that today’s winners are rarely tomorrow’s winners.

With a longer-term perspective and a disciplined approach, we can sit back confident in the fact that we will participate in tomorrow’s winners as we own them today, somewhere in our richly diversified portfolios.

[1] The Psychology of Money (to be published on 9th September 2020). Review: ‘Morgan Housel’s new book clarifies – with razor sharp and accessible insight – that building wealth is a mindset problem, not an investment problem. This is the first book any investor should read; in conjunction with a good index fund, becoming wealthy lies within everyone’s grasp.’ Tim Hale, MD at Albion Strategic Consulting, and author of Smarter Investing: Simpler Decisions for Better Results
Risk warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product.  Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
Header image by Dan Smedley on Unsplash