Life is always uncertain – no one knows what will happen tomorrow. I tend to refer back to guidance gleaned from Dale Carnegie’s “How to stop worrying and start living”. This timeless classic, written in the 1950s, tells us that most of the things we worry about never actually happen. It also urges us to worry less, especially about things we can’t control.
A useful piece of advice in this book is to write down our fears, including what impact they might have should they materialise, which can help us prepare mentally for the worst. Then we should calmly try to improve on the worst case.
I try to follow this advice when faced with uncertain issues, like the coronavirus. I have thought about what the impact might be and worked through an action plan should it materialise. I feel better even though I still don’t really know how it will play out. And, no, I have not stocked up on non-perishables.
How does this affect my retirement savings?
Investing, like life, involves considerable uncertainty. No-one knows what their investment outcome will be at some future date, or if their capital will last their retirement. The investment industry, which tends to prefer jargon over plain English, calls uncertainty risk.
Uncertainty does not stop us from investing. Rather, we use proven investment principles to help improve our outcomes: invest according to your time horizon, minimise costs, invest for growth by owning blue-chip companies (the stock market), diversify your investments by investment type and geography, and don’t try time or beat the market.
Crucially, though, the most important aspects of investing are within our control: Ensure you are saving adequately, invest sensibly using the above principles, and stay the course ie do not cash out your savings along the way even if things get a little hairy and the stock market responds negatively to an external event, such as the coronavirus.
The current stock market price is an estimation of the future earnings of all companies for a very long time – at least 50 years. It is impossible to accurately predict the next 50 years, so this estimation carries high forecast risk and is sensitive to small changes in the underlying assumptions. This partly explains the volatility of stock markets, especially during a period of high uncertainty like this.
As long-term investors, we should expect to experience a few financial crises over our investment lifetime. Other recent crises we have survived include the 2008 Global Financial Crisis, the 2000 Technology Bubble, the 1987 Stock Market Crises and the 1970 Oil Crisis, to name but a few. We can’t reliably predict a crisis but know they have featured regularly in our investment environment since the South Sea Bubble in 1720.
What should an investor do in a crisis?
‘Do nothing’ is not what you want to hear, so here is my best advice. Ensure you have the best investment strategy, based on the investment principles above, to meet your financial goals. Most people in South Africa don’t. They are paying high fees and investing their savings with fund managers who promise to the beat the market, but don’t. That investment strategy is likely to deliver a poor outcome in any environment, never mind in a time of crisis.
While it is tempting to try to time the markets during a crisis, like selling shares to invest in cash at a time like this, this seldom pays off. There are thousands of professional investors out there, a handful of whom have managed to time one crisis, such as the 2008 Global Financial Crisis. However, these managers did not display this prescience with other past or future crises. Their occasional brilliance seems to be more luck than skill since no professional investor has successfully timed markets over consecutive crises.
Trying to time the market in a time of crisis like this is not realistic. We don’t know when the crisis will end so it is not obvious when to exit, or when to re-enter.
What we do know is that investment risk falls when prices fall because lower prices imply lower expectations of future economic growth and corporate earnings. This logic contradicts our emotions. We tend to be more confident when stock markets are rising due to rising expectations of future earnings. This is illogical. Buying companies at higher prices is riskier than buying them at lower prices. Remember, the stock market is trying to estimate these companies’ future earnings over the next 50 years.
“In the short run, the stock market is a voting machine, but in the long run, it is a weighing machine.”
- Benjamin Graham, Warren Buffett’s mentor
Ben Graham’s quote from 1950, explaining how stock markets are driven by emotions and sentiment in the short term, but by profits in the long term, is noteworthy today.
I don’t think it is unreasonable to expect (but obviously there is no guarantee) the coronavirus to be contained within the next 18 months. Hopefully, that will happen sooner.
Aggregate company profits are unlikely to be negative during this entire period but will fall, as will dividends. There will be a cost to pay for this, probably around one year’s growth in corporate earnings, equal to around 5%. This is a high-level estimate to illustrate a principle, and is below the 10% correction in global stock markets and SA’s 13% fall for the year to 9 March 2020.
In summary, we at 10X don’t believe that investors should change their long-term investment view as long as their investment strategy is appropriate for their investment goals and is based on proven investment principles. If not, a crisis like this presents a great opportunity to address any failings.