Illustration: Colin Daniel
In Charles Dickens’s famous story A Christmas Carol, the central character, Ebenezer Scrooge, is visited by three ghosts: those of Christmas Past, Christmas Present, and Christmas Yet to Come. The ghosts force him to re-evaluate his life, and Scrooge becomes a kinder, more generous man, more aware of his environment.
Analyst Michael Dodd uses the literary analogy to put investing into historical context. He hastens to say he does not suggest that investors are cold-hearted and miserly, as Scrooge was, although, in common with him, they have an interest in money. He does suggest that, like Scrooge was forced to do, investors need to re-evaluate their behaviour, adapt to change and learn from their mistakes.
GHOST OF INVESTMENT PAST
Unlike Scrooge’s ghost, who reminded him of his painful past, the Ghost of Investment Past reminds us how good things were before 2008, Michael Dodd says, both locally and on foreign markets.
South Africans have experienced much change over the decades, he says, from the apartheid era, through the times of economic sanctions in the 1980s, to the birth of democracy in the 1990s. There have also been economic policy changes, such as the introduction of inflation-targeting by the Reserve Bank, introduced in 2000. Since then, inflation has been considerably lower, on average, than the high inflation of the 1980s and early ’90s.
The local equity market has performed spectacularly well, and investors have enjoyed a “golden period, which we are unlikely to |see again as the market matures”, Dodd says.
The FTSE/JSE All Share Index has steadily climbed from about 70 points in 1960 to over 50 000 today. Dips in its climb can be linked to significant political and economic events, Dodd says, but, although those events were significant, over the long term the trend continues to be up, and their short-term significance diminishes.
“The fact is,” Dodd says, “that short-term events can often be quite distracting when we, as investors, are trying to focus on the bigger picture. And, quite often, those things that seem to be pressing concerns in the short term can often just end up fizzling out when we consider them in a longer-term context.”
The high-returns world of the past few decades was not confined to South Africa, Dodd says. Globally, there were high returns for both equities and bonds, as a study by Credit Suisse shows. Between 1950 and 2012, equity returns in most countries were about seven percent annually (after inflation) and bond returns ranged between two and four percent. Since 1980, however, both equity and bond returns (barring Japanese equities) have been high in real terms.
“Don’t forget that this is a period that captures things such as the technology bubble, the emerging market crisis and the global financial crisis,” Dodd says.
GHOST OF INVESTMENT PRESENT
The current investment environment is a mix of good and bad, Michael Dodd says. First and foremost, we are in an era of extraordinary central bank action as the world still deals with the aftermath of the 2008/9 crisis. Interest rates are at all-time lows to stimulate economic growth. The good news, Dodd says, is that, by and large, the monetary stimulus has worked, with growth in many developed countries starting to pick up.
In the United States, low short-term interest rates have had a knock-on effect on longer-term bond yields, which are currently trading close to historical lows (levels last seen in the 1950s).
Here in South Africa, the repo rate is a relatively good proxy for the returns that investors can earn from cash, Dodd says, and for the past three years inflation has outpaced returns on cash. This means that cash investors have experienced negative real returns over this period.
Forecasts by the Reserve Bank show a “pretty bleak picture” of slowing economic growth, while inflation pressures force the bank to up the repo rate as it sticks to its mandate of inflation-targeting. In addition, the rand has weakened and appears to be undervalued on a purchasing power parity basis.
Dodd says that looking at the local and global equity market from the past five years, it seems “the bull has been hogging the limelight, while the bear has been waiting anxiously in the wings”. No one can predict exactly when the bear will get its turn, he says, but some signs are pointing to it possibly being soon.
One thing appears relatively certain: you can’t extrapolate into the future the high returns that equities are enjoying now. In South Africa, in particular, price-earnings ratios (an indicator of share value) are high relative to their long-term averages, suggesting that shares are expensive.
Valuation remains an important factor when making investment decisions. “You can buy the best-quality asset in the world, but if you pay too much for it, your subsequent returns will not be as good as they could have been had you paid a better price,” Dodd says.
Apart from the traditional factors that cause markets to go up or down, there have been fundamental changes in the mechanics of investing, which are causing markets to behave differently. The US advisory company LPL Financial has found that holding periods for shares have declined from just over eight years, on average, in the 1960s to just a few weeks today. Investors are becoming more short-term focused, blurring the line between investing and trading. Advances in communications, the advent of high-frequency algorithmic trading, and the rise of passive products, such as exchange traded funds, come on the back of technological advances, to the point where computers do the work for us.
Dodd says the dangers of algorithms and automated trading are illustrated in an incident that occurred on the Amazon website a few years ago, where a book’s price shot up to unrealistic levels because there were only two copies available from two different sellers. Each seller created an algorithm to set the price, and they locked into a loop, driving the book’s price from $90 to over $23 million a few days later.
GHOST OF INVESTMENT YET TO COME
Dodd began his look at the future by illustrating the dangers of forecasting with a video clip of CNBC TV presenter Jim Cramer imploring investors in March 2008 to hold on to their shares in Bear Stearns (the American investment bank that imploded spectacularly days later).
We live in a world of constant connectivity, he says. Social media is playing an increasingly bigger role in our lives, and this is affecting our investment behaviour. Twitter, for example, is increasingly a source of investment news in real time. Social media enables us to communicate with people we wouldn’t normally have access to, such as investor Warren Buffett.
The “twittersphere” has its pitfalls, though. On April 23 last year, the Associated Press’s Twitter account was hacked and a fake tweet reported explosions at the White House, with President Barack Obama being injured. The Dow Jones Index plummeted, then quickly recovered in intraday trade.
This shows, Dodd says, that even though we have made tremendous technological advances, we still remain emotional and irrational creatures who react poorly to things at the best of times, and we need to be aware of our limitations.
Potential themes for the near future, according to Dodd, are:
* The unwinding of the era of monetary stimulus and the risks this poses to global bonds and asset classes generally. We don’t know what the effects will be.
* The rise of Africa as an investment destination, which will provide interesting new options in the portfolio mix from a return and diversification perspective.
* The emergence of new asset classes – the ultra-rich are investing in assets with scarcity value, such as farmland, prime real estate and collectibles.
* An increasing focus on the social aspects of investing – institutional investors, such as retirement funds, must now consider environmental, social and governance factors when making investment decisions.
* Declining fees: fund, trading and advisory fees will come under pressure with increased automation. The passive investment market is taking business away from active managers.
* A shift in focus to the customer. In South Africa, the Financial Services Board’s Treating Customers Fairly programme is an example.
* An increase in DIY investing.
But with so much more information available to you, there is still a need for expert input, even for DIY investors. Don’t be ashamed to be a “googler”, Dodd says. The greater your knowledge, he says, the more this raises the level of discourse with your financial planner.
OTHER ADVICE FOR INVESTORS:
* Try to maintain a long-term focus in an increasingly short-term world, and try to remain calm;
* Stay disciplined;
* Constantly question and re-evaluate your investment strategy; and
* Be ready to adapt to change.
* Past: This gives us perspective, helping us to appreciate where we have come from, how we have done things, and helping us to learn from our mistakes, Michael Dodd says.
* Present: The current environment remains uncertain, with extraordinary central bank actions determining the direction of most asset classes, he says. We find ourselves in a constantly changing world, where the need to be constantly informed, nimble and able to adapt are important.
* Future: Increased focus on technology and real-time news flow lead to investors being better informed, but can also lead to greater irrational behaviour, Dodd says. The role of the financial planner remains vital.