This time last year, a lifetime ago, I wrote a piece making four predictions for what was coming in 2023.*
It was all a bit of fun, and not at all serious, but it definitely does leave you open to looking a bit daft. However, one of the upsides of writing a piece like this is that you can wheel it out again every twelve months in an effort to squeeze as much mileage out of it as possible.
It can be difficult sometimes to come up with ideas for posts, especially when there are frankly better things to do over the festive period (mainly related to carbohydrate ingestion).
But I’m not going to bother doing something similar this year. 2023 has offered up more than enough lessons for us as investors, and I reckon that we can learn a lot more looking back at the last twelve months than we can from navel gazing. And let’s be entirely honest, forecasting what is going to happen in the next twelve months is a totally pointless exercise anyway.
This time last year I wrote “sentiment is pretty grim at the moment. Consensus thinking expects a recession and a subsequent, as yet unclear, knock-on impact to company earnings.”
This negativity was writ large in investor sentiment indicators in December 2022.
The CNN “Fear and Greed” index sat firmly in fear territory. And an average measure of investment analysts’ recommended equity allocations, produced by Bank of America, sat at it’s lowest level since 2017.
In other words, a year ago the pros were recommending that you de-risk and proceed with caution.
There were very good reasons to be somewhat nervous going into last year. There always are. Negative sentiment will never exist in a vacuum.
One of the key reasons for investors to be a little more conservative in their stock allocations twelve months ago was that cash was back baby. There were fixed term deposits offering 4% from pretty early in 2023, and for a generation of savers starved of any kind of return on their cash, this number was pretty attractive.
But by moving money to cash in order to take advantage of this “juicy” yield an investor is, perhaps unknowingly, exposing themselves to two potential risks.
The first I believe is pretty well understood. The reason that cash rates were going up of course, was that prices were rising even faster.
4% or 5% looks somewhat less attractive in the context of double digit inflation, but most folks don’t think in real, inflation adjusted terms - they think in nominal terms. They see the rate on offer, see that it has gone up relative to the 0% level that they have become anchored to over the previous decade, and simply ignore the fact that by remaining in cash the pricing power of their capital is being eviscerated even more quickly that it was before.
The second risk is less obvious. Opportunity cost.
History shows us that returns from the stock market tend to typically be lumpy. What I mean by this is that performance has historically tended to arrive in short violent bursts, rather than being conveniently spread gradually over time.
Just look at the performance of the global stock market over the last year. Two thirds of 2023’s return arrived in the final two months. If you didn’t stick around for November and December - you got a far worse result than was otherwise available to you.
Source: MSCI. Returns are shown for the MSCI ACWI (All Country World Index) in Sterling terms, indexed to 100.
One of the hidden dangers of making short-term, spur of the moment tactical changes to your long term asset allocation is that you never know when these lumpy market returns are going to arrive. Short term equity market performance is inherently unpredictable, and the big returns can arrive when you least expect them.
As ever, I’m afraid that the best approach is the one that leaves the least room for significant error. Money invested to meet long term objectives should be left alone for the long term. It’s boring, but that doesn’t make it bad advice.
In seeking to extol the virtues of staying invested, many investment companies produce some variation of a chart that shows how much worse investor returns are if you miss out on the “best ten days of the past one/three/five years” (delete as appropriate).
What these charts conveniently tend not to mention is that these “best days” often arrive during periods of significant volatility. That is to say, the market does not tend to be playing nicely when the highest daily returns arrive.
Looking at the best ten individual days in the stock market over the past three years as an example, three took place during October 2022 - the recent market “bottom”.
30th November 2022: 2.95%
21st October 2022: 2.64%
16th March 2022: 2.55%
24th June 2022: 2.49%
28th April 2022: 2.37%
1st March 2021: 2.36%
13th May 2022: 2.34%
9th March 2022: 2.26%
18th October 2022: 2.13%
4th October 2022: 2.11%
Source: MSCI. Again returns are for the MSCI ACWI Index, in Sterling terms.
It is a cruel irony of investing in financial markets that the best short term returns are to be had at the points of maximum pain.
But there is simply no way to cheat the system, you can’t have the gain without the pain.
Moving money which is invested for your long term future into cash at the beginning of the year in order to lock in a “risk free” 4% might have made some logical sense. Even if that logic is rooted in some of our most basic human biases - fear of the unknown, loss aversion.
However, by making that decision you run the very real risk of missing out on great returns if the stock market rips. And last year was a very decent one for equities, with the global market up by 17% in the end.
We invest in equities to outperform cash over sensible timeframes, not over just one year. But there is no getting round the fact that if you shifted to cash at the beginning of 2023, like lots of clever people were suggesting that you do, the opportunity cost of that decision has been material.
There are now two choices for those who find themselves in this position:
Learn the lesson, and re-invest into the market; or
Double down. Stay in cash and wait for the next big disaster to arrive so you can “get back in”.
I have seen entire financial plans fatally undermined because investors chose option two and have ended up trapped in cash while the market sails into the distance. Please choose wisely.
Opportunity costs compound by just as much as equity market returns.
* For the record - I’m going to give myself a score of two and a half out of four on these predictions. Inflation did fall by a lot, but not because of a recession so I’m only going to give myself a half point for that one. The less said about where I thought interest rates were going, the better.
Please note that any past performance referenced in this article is not indicative of future returns.
Comments