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Don’t be fooled by the tide: In investments, context matters

Even great companies don’t always make good buys.
Image: Taylor Weidman/Bloomberg

Investors need to let go of the idea that the stock market is one uniform entity. Such thinking implies that all shares behave in a similar way, which isn’t the case at all. Just because “the market” is up, doesn’t mean all shares are, and similarly when it is down, there will still be some shares that are performing well.

While investors like to see themselves as unbiased decision makers, prevailing market narratives can often cause investors to lose sight of the bigger picture, relying on recent winners to keep carrying performance, and avoiding areas which do not get positive press. Our decisions to buy or sell, and the price gyrations of shares themselves, should always be seen in the bigger market context. The price we are prepared to pay for an investment should be the result of the expected probabilities of a range of future outcomes.

Even great companies don’t always make good buys

A popular myth holds that if you buy shares in good companies and hold them long enough, you will make money. For example, the compelling narrative behind big tech has driven the prices of these shares to extreme valuations, apparently proving this point. But the ‘share prices of good companies only go up’ narrative is not always true. Pay too much for your initial investment based on valuation and you are likely to wait a long time (sometimes even a decade or longer) to see growth on your investment.

The Japanese market is a good example of how a large group of companies represented in the Nikkei Index became very expensive in the late 1980s. Japan as a country, the Nikkei as an index and many firms in the Japanese market, could just do no wrong. Property values and price-earnings ratios rose and rose. You might even have been fooled into ‘safety’ by buying the index at the time, seeing that as a passive investment, even though in 1989 the Nikkei Index traded at almost 60 times earnings. Of course, every investment decision turns out to be an active one and buying the Japanese ‘market’ in 1989 led to entering an investment at a level not seen again for over 30 years. This is an extreme example, but it makes the point well. Buying a share ‘at any price’, either individually or as part of an index, is neither a sound nor sustainable investment strategy and ‘fear of missing out’ does not provide a sound basis for robust portfolio construction.

Nikkei 225 Index price levels

Source: Bloomberg

Patience and perspective let you see the bigger picture

There are costs to buying into prevailing narratives, and those who are serious about building wealth in the long-term realise that a sound investment strategy has several facets. Avoiding a share simply because its share price has not performed ‘well’, or selling it because it has not ‘done as well’ as some others, is as precarious a strategy as buying a share at ‘any cost’. Many basic passive index trackers do this by virtue of being price insensitive market participants. While index investing can be a good contributor to an overall portfolio, the narrower a market becomes, the more risks increase (such as portfolio concentration or lack of diversification), and the more you need to broaden your exposure. The challenge is that momentum and sentiment can carry popular areas of the market into the stratosphere, fuelling the belief that winners will remain winners indefinitely, just because they have been so far.

Investors picking shares without considering the bigger picture or the long-term plan, are likely to be disappointed when prevailing conditions turn out to be substantially different to the conditions that had pushed these valuations up in the first place. Don’t be fooled by the tide – now more than ever, the market is not one amorphous mass. Different parts are behaving in vastly different ways. Sound investments are made when you base your decisions on a sober assessment of fair value, ensuring that your portfolio can withstand several future scenarios. This remains the only sure-fire way to ride out the ebb and flow of investment markets and create portfolios capable of building long-term wealth.

Anet Ahern, CEO at PSG Asset Management.

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Being a long term investor makes sense if you have large capital because your dividend justify it. However, if you have a small amount of capital then it does not. Rather, being a position trader to grow your capital is a better option for small fry’s like myself. However once my capital becomes large enough to justify long term investment then YES!

If you earn more with a position- or swing trading strategy that incorporates a stop-loss system, why would you ever want to be a buy-and-hold investor?

The risk is in direct proportion to gearing. If you do not use gearing then the risk with a position trading strategy is much lower than with a buy-and-hold strategy.

The reality is that the investment universe is finite. Once a share has been issued, it will always, at all times, belong to someone. For one investor to be able to sell, another must buy. Nobody wants to lose money. Everyone applies his mind to pick the winners. They act out of conviction.

The point is that over the longer term, considering the myriad of variables that impact price movements, all the numbers are in the hat and the girl with the big hair and small dress will pull the lucky number.

I have nothing against lady luck, but I am more comfortable with trend and momentum. With my two friends, trend and momentum, I do not have to guess, anticipate, calculate or assume. When they change their minds, they tell me immediately. They do not lie. They are boring company, but at my age, I prefer them to Lady Luck who is all over the place.

I agree. Swing trading together with scalping and gearing is my long term strategy. Trend is your friend. Buy and hold will proof costly very shortly when asset bubble bursts.

I think Moneyweb should have an editorial policy that any fund manager submitting an article for publication should, also, publish their investment returns over at least 5 years.
In the case of PSG their returns have been abysmal but time after time it receives massive exposure in various websites, including MW.
Ill-informed investors base their investment decisions on these articles.

End of comments.

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