The Globe and Mail, Report on Business
Published October 1, 2011
By Tom Bradley
“In calmer moments, investors recognize their inability to know what the future holds. In moments of extreme panic or enthusiasm, however, they become remarkably bold in their predictions: They act as though uncertainty has vanished and the outcome is beyond doubt.”
These words are from the late Peter Bernstein – analyst, strategist and author of Against the Gods: The Remarkable Story of Risk.
When we look at today’s investing landscape, there’s a lot we shouldn’t be certain about in the political, economic and business arenas. But at the risk of ignoring Mr. Bernstein’s counsel, the current market fray does make me more confident about some things.
Bond returns will be poor
With a further decline in yields, the math for bondholders is even more dismal than it was just a few months ago. If yields stay at these low levels, investors are going to earn 2 per cent before commissions, fees and taxes. If rates rise, they’ll eventually achieve better returns, but not before experiencing capital losses on their existing bond holdings.
Expect more from stocks
Stock prices always take a more winding path than do the company fundamentals that underpin them. With a recession looming, the outlook for corporate profits in the short (and perhaps medium) term has worsened. But true to form, stocks have more than reflected that and price-to-earnings multiples are now down to attractive levels. This has occurred despite the fact that only a small part of any stock’s value is derived from near-term earnings.
At client presentations in January, I suggested that stock returns over the next five-plus years would be between 5 and 8 per cent. I arrived at that intentionally wide range (I’m uncertain) by adding dividends (2 to 3 per cent) to corporate profit growth (3 to 4 per cent) and assuming no change in valuation multiples. (Note: The growth number is well below the historical pace of 6 per cent). Today, however, my range is 7 to 10 per cent. To get there, I’ve left the first two variables unchanged (although dividend yields are higher now) and built in an improvement for future valuations, which will produce higher returns.
Relax, everyone is bearish
An investor was recently heard to say, “The market may not have bottomed yet, but I have.” I’ll resist quoting Warren Buffett, but suffice to say that when everyone is beaten up, discouraged and fearful, risk in the market is substantially reduced and opportunity is greater. That’s because when people are negative, most of the selling has been done and the bad news is largely factored into security prices. A bearish consensus is a prerequisite for a market bottom and sets the stage for above-average returns on the way back up.
Moving from market generalities to portfolio specifics, there are a few other things I’m more certain about. First, investors in the accumulation phase who have a long time to invest are being given a gift. At current prices, they can buy more shares with the same amount of money.
Second, investors who haven’t yet rebalanced their portfolios have a lower percentage in stocks than they did when the market started its decline six months ago. If they want to ride the market back up with as much as they went down with, then it’s a mathematical certainty they’ll need to do some buying.
And finally, this is a time when investors should lean on their long-term plan, not rewrite it. It’s tempting to make changes that match the magnitude of the market declines, but what’s called for are small, incremental moves (that is, rebalancing). With emotions running high, the chance of a major overhaul going seriously wrong is also high.
Mr. Bernstein says market bottoms are defined by a “switch from doubt to certainty.” On that measure, I don’t know if we’ve seen the lows yet. Certainly, I’m guilty of being more confident about some things, but be assured my list doesn’t include what’s going to happen to Spain, interest rates, gold, Swiss francs, credit spreads, correlations, GDP growth, copper, volatility, the U.S. dollar, profit margins, China’s real estate market, natural gas or where the market will be next month.