Have we got it all wrong? – by Andró Griessel
August 5, 2014
Don’t miss 28 February – by Samuel Rossouw
February 19, 2015

How to cope with volatility – by Andró Griessel

How to cope with volatility – by Andró Griessel

 Looking at the heading of today’s writing, you would be forgiven for thinking that I am trying my hand at relationship advice.  The volatility I am referring to here is not the type you experience when your partner comes home in a bad mood though, but the type we encounter in financial markets and predominantly refers to periods of strong market declines.  Unlike your ability to maybe change your partner’s mood, there are not a lot you and I can do about the tantrums markets throw from time to time.  Herein lies part of your answer on how to deal with market volatility.

When people first asked Warren Buffett if he would invest their funds, he was hesitant.  He knew from an early age that most people are too irrational to do well in investments.  Because of the age old emotions of greed and fear, people would sabotage their own chances of earning a decent return on their capital.  He agreed on one condition, and that was that he would only write to the investors once a year and that he wouldn’t take any questions or calls during the year.  Mr Buffett knew very well that the best way to reduce the volatility of financial markets was to simply not look at it or report on it that often.  See graph below of the top 40 shares (in size) on the JSE over the past 20 years.  The red circles represent market declines of more than 10%.  These are typically when people start to feel uncomfortable, asking questions about how far it will go and if they shouldn’t “sit it out” and invest again when things are calmer.

Over this 20 year period we have had no less than 18 periods (current period included) where the market has fallen with more than 10% in a short space of time.  Four of these 18 periods saw the market decline by more than 20% and at 3 occasions the market declined by a very uncomfortable 30% or more.  Something that is very important to note is that in the subsequent 1 month period following each of these periods of decline, the market rose with a cumulative 224% (13.2% per month).  This makes it very difficult, and in my view unwise, to attempt to sit out these periods in red and then re-invest later.  You will just find yourself buying in again at higher levels than those at which you exited.  By telling his investors that he would only report once a year on their investments, Mr Buffett accomplished a very important thing…he reduced their perceived volatility dramatically.  By looking at your investment in the JSE only once a year, the picture below would emerge.

I don’t know about you, but to me this looks like a much more palatable investment than the one with the 18 periods of “significant” falls.  Do you agree that the investor getting the above feedback will be much less inclined to make sudden emotional changes than the poor investor who is being bombarded by declines at least once a year?

Today it’s expected of investment companies to send statements on a quarterly basis.  Many people even have online access to their investments and can check it every day.  Clients of ProVérte will know that we strongly discourage this.  If we had a choice, we too would talk about market movements only once a year at review time.  See below what a quarterly view of the market looks like.

This paints a much better picture than the daily chart that comes up with 18 opportunities to panic and illustrates once again the benefit of looking at your investments less frequently.

So should one stick your head in the sand like an ostrich and stay in the same investment forever regardless of what is going on around you?  The answer to this is YES and NO.  It is very important to understand what you are invested in.  If you are invested in a well-diversified portfolio of stocks and/or assets where the underlying funds are being actively managed, the answer is yes.  You simply have to relax and allow the people to whom you have entrusted your funds to do their job.  If however you are invested in a single stock/share or 2 or a single asset class, then sticking with the status quo might not have the desired outcome.  This is especially true if this one stock or asset class is trading at very lofty valuations.

When thinking about investments it is very important to understand the relationship between earnings and price and that over long periods, price will follow earnings.  There is no such thing as a permanent decoupling between earnings and price.  If the price outpaces the earnings, be sure that it will revert back to the mean at some point.  This is also true when it’s the other way around.  See below a graph of the earnings vs price appreciations on the JSE over the past 54 years.

In a company like SA Breweries or British American Tobacco this growth in earnings is fairly constant and predictable and you could expect that the share price will have similar characteristics as the JSE All Share Index i.e. an ever up-sloping price with certain bumps along the way.  When you invest in cyclical companies (like gold mines) it is a completely different story, as their profits and losses come in leaps and bounds.  At times they make record profits and at others they make record losses due to factors like commodity supply and demand and exchange rate movements.  An investment in a firm like AngloGold for example would have returned almost 0% over the last 30 years, had you invested in it and forgotten about it.  On the other hand, professional investors who bought at low points and sold at high points would have made big profits.

So what to do?

Success in investments is determined predominantly (if not completely) by the quality of the process you follow in making the investment decisions.  If your fund manager and/or financial adviser follows a disciplined approach in constructing your portfolio and you stick to your long term goals, there is no reason why market volatility should move you to make any drastic changes.  Volatility is quite a normal occurrence and should in fact be expected.  You should actually experience discomfort when there is a complete lack of volatility as was the case in 2004-2007 and between 2012 & 2013.

No one has clear insights into how long the current slump will last or how deep it will be.  Any time spent on trying to predict it would be time that we could rather spend on the golf course.  If your portfolio was correctly structured based on your specific circumstances and goals you should not take too much notice either.  Keep your eye on the long term goals and make sure that even on conservative assumptions you will still reach those goals.  Maximum returns over all periods and under any market conditions, is not a goal.  If this is your expectation from your fund manager or financial adviser then the chances of being disappointed are very high.  If market volatility really makes you nervous and detracts from your quality of life I only have one piece of advice…Don’t look at it that often.

Traders can cause short-term volatility.  In the long run, the market must revert to a sensible price/earnings multiple. – Ben Stein

Please contact the author (Andró Griessel) if you have any questions or comments on this month’s 2Cents.

Disclaimer: Although all possible care was taken in the drafting of this document, the factual correctness of the information contained herein cannot be guaranteed. This document does not constitute advice and anyone planning on taking any financial action based on this document, is strongly advised to first consult with their personal financial advisor. ProVérte Wealth Management is an authorised financial service provider with FSP no. 5966.

Andró Griessel
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