Whilst I mused on the difference between investment and speculation in January of last year, the reality of what constitutes market risk hit many full in the face from October to December of 2018. Fears of ‘trade wars’ hitting economic growth, combined with other reasons provided by the commentariat led to sell orders, fund redemptions (requiring more sell orders to meet year end redemption notices) and broadly a preference for cash over shares as the calendar year rolled over.
For those who held their nerve (or more accurately their stocks) through this period, I suspect many will be nursing significant losses where their holdings were either unconventional (or simply bad) investment ideas. As for differentiating between the two, I am increasingly of a mind that for something to work truly spectacularly, it is likely to be seen by the majority as unconventional (or simply bad), as investment ideas go.
In the world of the fully invested quality investor, however, it does not seem to me that much has really changed through what is being termed by many as recent market turbulence. The broad indices are close to (around 10% off) their all time highs. Interest rates are still low, which should keep risk assets priced at high levels vs their expected future cashflows.
It is a near certainty that a significant rise in interest rates would mean lower share prices in a general sense. With government bonds yielding historic lows, the temptation is to assume mean-reversion and expect a poor stock market performance. But over what time-frame is the question. And, more importantly, what else is there to do with your capital over that period?
One remedy for the dilemma of trying to time markets, as I have previously noted, is simply not to do it. Just hold good businesses and when bargains are few and far between, accept that the quoted value of your portfolio may ‘suffer’ from higher discount rates or lower expected future cashflows. Over time, however, the benefits of being a holder of equities should fully compensate the mental anguish that may (or may not) be caused by swings in quoted values.
Another path, and the one that I chose to select in late 2018 as my more speculative holdings were hit harder than the broad market, is to move to cash. And cash, whilst yielding next to nothing at present, at least has the advantage of not going down in a market decline. It offers optionality to the holder over possibly lower future share prices. And yet... it could simply be a form of market timing to say that cash is more attractive than holding shares at any given time.
The dilemma is solved, to some extent, by revisiting what exactly are your investment goals. If you are in the protection-of-capital-with-slightly-better-than-the-broad-market-growth-camp game, then being underinvested for even short periods can harm performance over a long period (witness the January 2019 market bounce). If you are in the significant-outperformance-and-high-compound-rate-of-growth game, then avoiding drawdowns and protecting capital by seeking out favourable risk-reward situations with limited expected downside and good upside potential may require periods of holding cash. Is this market timing? Possibly. Is it speculative? Probably. But at least by returning to the core of what it is that you are trying to achieve with your portfolio - and thinking through the strategies with which you wish to achieve your goals - can lead to periods of holding cash in some instances.
As for the portfolio’s performance itself, 2018 brought huge growth on top of the 2018 high performance... until the summer came... and then it all went into reverse. The total return for 2018 was positive in cash terms, but brought my first negative return (-1%) in money-weighted terms. I held cash into the end of the year as I cared (somewhat ridiculously) about the -1% figure and didn’t want it to get worse. To then view various businesses I had recently owned (and liked at current levels) bounce by 10-20% in January, was a lesson in the ill potential of trying to time markets vs just sitting through the potential turbulence in quoted prices.
In any case, if the goal is a 20% compound rate of returns over a long period of time, a few months of performance is unlikely to affect the broad outcome. But taking that goal, and trying to achieve it with cash for any extended period is unlikely to work particularly well. Owning solid, sensible, large-cap businesses is also unlikely to meet the above goal (unless the starting point is a more subdued price environment than exists in early 2019). And so, it’s a case of keeping the gun loaded, looking for targets, and waiting to pull the trigger when prices are at attractive levels. A more speculative approach than the conservative investor would hope to employ, but one which can at least benefit from market dislocations should they come about again... and they do have a tendency to come around from time to time.
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