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The bottom of the markets: Are we there yet?

We are closer to being at the bottom of the market than we were last year this time.

Instant gratification. Something that most of us simply cannot live without. This trait surfaces in a lot of areas in our lives. Whether it be in our relationships, careers, or finances. The list is never-ending. One area of our daily lives where this is probably seen most of the time is when it comes to personal finances – and even more so, investment portfolios.

You allocate your capital to an investment, and the first thing you want to know before the transaction is even completed, is how much money did I make, or perhaps how much money will I make? Instant gratification is probably one of the biggest traits leading many investors to a downfall, because (believe it or not), waiting helps you as an investor. A lot of people just cannot stand to wait. Charlie Munger said: “if you didn’t get the deferred-gratification gene, you have got to work very hard to overcome that.”

The other scapegoat for the irrational behaviour of investors is fear. As we all know by now, people react in one of three ways when facing fear: flight, fight, or freeze. And unfortunately, the first option is normally opted for by investors, whereas fight has historically (and statistically) led to better results for investors.

It should be remembered that only fear sells, and only fear drives reaction. Thus, the news headlines will always be fear-driven, as this is what stimulates a response. Luckily for all patient and neutral investors, the market is ahead of the news, and by the time the headlines reflect the fear and failure, it will already be priced in. It is therefore of extreme importance to have a forward-looking viewpoint when decisions are to be made regarding your investment portfolio.

Therefore, the question remains: How do we know when markets bottom, and in today’s terms – are we there yet?

Trying to time the market is a fool’s game, but by having the required futuristic outlook and analysing the data, some conclusions can be drawn, and sense can be made, to a certain extent, as to where we are in the market. But before we look at the data, one thing is certain: we are closer to being at the bottom of the market than we were last year this time. Here is a simple graph of the S&P 500 index indicating exactly that:

Source: S&P 500 Data as at 26 July 2022

It is almost too simple for this statement to be making sense. We do not know as a fact when or where the market will reach its ultimate bottom, but what you can be 100% sure of, is that we are closer to the market bottom (irrespective at which level this may occur) since a year ago, and we are further away from another all-time high than we were a year ago. Why the statement, and what does this mean?

The answer is simple: the difference between the levels of the market at this given point in time is the margin where the opportunity lies for new (and existing) investors. If you were happy to take capital to the market basically at any stage up until December 2021, you would (and should) be more than happy to take capital to the market at current levels. Because one fact remains – the market will reach another all-time high again.

Let’s make the data do the talking – Global markets and the road to (or from) the bottom

Offshore

People are currently (but really always have been, and always will be) negative. Really, really negative. The question is now whether that could possibly be a good thing.

It is not a common sight for large fund managers to be overweight bonds relative to equities. This suggests deep negativity for the short-term outlook of the economy. The latest edition of Bank of America’s monthly survey of global fund managers found that they are now even more underweight stocks than bonds than they were in March 2009, which is the same month the stock market hit rock bottom after Lehman Brothers collapsed.

From one side, this is terrible news. The asset managers who deploy capital for long-term growth think it is better to lend money to the government (at still very low presumable rates) than to take a share in the profits of big and established companies.

But, and as I mentioned above, from the flip side, an opportunity might (and possibly is) be banging on the front door. Below is an indication of how stocks have performed since the beginning of 2009.

On the previous two occasions where asset managers went overweight bonds to stocks (2009 GFC and initial Covid lockdowns in March), the market turned around without any warning or good news flashing on the front pages. On the contrary, only doom and gloom were still to be found at these times, yet these were both excellent times to go long on stocks due to the deflated levels of the markets at the time. Investors were presented with the opportunity to enter the market at favourable levels.

A further survey by the Bank of America, aimed at some of the largest asset managers around the world, found that most of these managers have now (up until June) taken a lot of risk off the table by moving largely out of equities and into bonds as mentioned above. The net % of managers taking higher than normal risk levels has reduced significantly in the last six months, below levels seen in the Global Financial Crisis.

I know the voice in your head is shouting that this is very bad news. It was yes, back in December. But once again, this data can be taken as evidence that the market overall has already taken more than enough evasive action and that we might be reaching full market capitulation. (Capitulation is the extreme increase of selling pressure in a declining market. The resulting dramatic drop in market prices can mark the end of a decline, since investors who did not sell during a panic are unlikely to do so thereafter.)

What is the best strategy in a declining market, with the bottom expected to be close?

In layman’s terms, the best thing you can do in these times, and keep doing, is to contribute money towards your investments, effectively buying shares each month at a cheaper price than the month before. I will try and explain this in a simple example and compare an investment that has taken a market dip while getting contributions with an investment that did not receive contributions through the market drop.

Let’s say a share is worth R1, the share has three months of bad performance and one month of good performance thereafter (resembling a short market downturn and then bounce back)

Share performance:

Month 1: -6%

Month 2: -8%

Month 3: -13%

Month 4: 30%

Investment 1: Starts with R50 000 and contributes R10 000 pm.

Investment 2: Starts with R50 000 and doesn’t contribute.

  • Investment 1 has grown to R93 619.64 because it kept making contributions to the shares on a monthly basis, buying the shares each month at lower prices, and when the upturn came Investment 1 had a lot more shares than Investment 2 had to generate the growth from.
  • Investment 2 only managed R48 904.44, this means it did not even reach its initial investment value of R50 000 yet.

The conclusion is exactly what Warren Buffet mentions in all his books. He made most of his money being invested and contributing throughout the biggest market crashes in history. Including World War 2 where he made most of his initial wealth buying stocks that were falling each month.

The resulting summary

It is impossible to time the markets. But by having an in-depth look at some of the (even gloomy) data, one might be able to have a clearer picture of the markets and the way forward. If you have a close look at the data above, you will see clearly that a lot of fear is already priced in the markets. The war, inflation, Covid, supply chain pressures, etc. What is more important, is that the biggest percentage of large global asset managers have already made the moves from growth assets (equities) to risk-averse assets (cash and bonds).

Why am I restating this? The reason is simple.

If you do try and make the same changes in your own portfolio or continue sitting on cash in this macro-economic environment, you might (and soon will) miss the opportunity presented to you as an investor. Once the market has turned for the better, you will still be sitting on the sidelines, then asking questions such as “isn’t the market too high to buy?”

Markets are forward-looking and require investors to have the same sentiment. If you are investing capital based on only existing/current market factors, you will have the urge to make switches daily. The importance of having a forward-looking approach cannot be emphasised enough.

The fact remains – we cannot time the markets and indicate the exact bottom, but we are closer to the bottom, and further from the top than we were a year ago. This is where the opportunity lies, and it is still on the table…

Ruan Breed is a financial advisor at Brenthurst Stellenbosch ruan@brenthurstwealth.co.za

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Ruan Breed

Brenthurst Wealth

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Great article with some very good advice. Thank you.

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