Market Update 26th February 2024

Greed and fear

It’s been a busy full year reporting season. The latest data from Factset shows that 79% of the S&P 500 have released results and 75% of these earnings numbers have been better than expected. That comes on the back of good revenue growth. With 8 out of 11 sectors ahead, only Utilities (-1.6%) Materials (-5.6%) and Energy (-9.2%) are behind on their toplines from last year… and it is not surprising to see resources revenue dip given the direction of commodity markets in recent times. The standout has again been Technology – with Nvidia once again shooting the lights out. The quality of that business is very apparent – but the volatility is slightly daunting. Timing purchases has proven difficult.

In fact, timing the market generally has always been a challenge. I did some digging around the Investment Association’s retail flow records. There have only been 9 quarters in recent years (I could only find quarterly data going back to 2007 on their website) where the aggregate of fund flows across all asset classes have been negative.

Taking 12-month performance from those quarters reveals some interesting results. The average subsequent return of the MSCI World after these 9 quarters was +16.1%. That’s a fair whack ahead of par. This data implies it does indeed pay to be greedy when the market is fearful. But does it also imply it is best to be fearful when greed dominates? The short answer is yes.

As above, the majority of quarters have inflows – so I looked at the largest 10 in the dataset. Interestingly, 2017 and 2021 were responsible for 6 of the biggest 10 quarterly inflows. The less said about subsequent returns into 2018 and 2022 the better. Of course, there were some quarters where performance was strong, which helped lift the average subsequent returns from these 10 periods to +7.2%. But that’s almost a full 9 percentage points below the quarters with the outflows.

Now, we shouldn’t forget this is a pretty small sample size and there are of course multiple factors in play – for example 2022’s outflows could be explained by rising mortgage bills rather than a fear of market falls.

But it does add further evidence to the school of thought that, when left to their own devices, investors can be their own worst enemy. There are numerous more detailed studies that back this up. My favourite is the analysis of the returns generated by the Fidelity Magellan Fund under Peter Lynch’s leadership from 1977 to 1990. The average annual return was a quite incredible 29% over this time. But according to Fidelity Investments, the average Magellan Fund investor lost money during this time. To think that kind of tailwind can be more than undone by poor market timing is absolutely extraordinary.

The typical cycle is something like this. An investor starts watching share X. It goes up. Our investor wishes they had invested from the outset. It goes up more. They see this as confirmation of their original thinking and consequently buy some shares. The price goes up more, and more money goes in. This stage can repeat, as investors get increasingly greedy. In the case of bubbles, this can turn into a frenzy where ‘fear of missing out’ takes hold. Eventually, the stock dips. Our investor, ignorant of valuation and without taking in any new information, buys on the dip. It drops more. Now they tell themselves it is best to ride out the volatility and decide to hold. Greed turns to fear when the falls continue, and getting out becomes the priority. Again, little attention is paid to what ‘fair value’ is. The result can be an unhealthy lack of rationality on both purchases and sales… Not a good combination.

What I’m trying to say is that managing the psychology of investing is a huge challenge for individuals. Sure, tracker-type products are cheaper and on paper can often have better track records. But the reality is that without expert guidance, many will not get the ‘on paper’ returns. Partnering with a professional investment manager who can deploy funds with a consistent strategy will cost more, but the expertise and assurance will, for many, be more than worth it.

George Salmon – Senior Investment Analyst

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