If there is one predictable outcome from the recent equity rout, it is that the behavioural theme has played out to plan.
The doomsters say they told us so and prognosticate on how it can only get worse; the perennial bulls lean on their great selection of quality companies with strong-as-ox earnings and cash flows, therefore the buying opportunity. Each speaks to their existing position rather than clear the air on what could transpire.
“Should I stay or should I go” – if you can’t remember who made the lyrics famous, a search engine will help out (it was British group The Clash). Then scroll down the page and quickly these words are used to offer advice on whether you should stay in a job or not. It applies to the uncomfortable decision on Brexit. Turn that to whether you should stick it out in the equity market or take time out – the process is largely the same.
All work environments have their testing times, no matter how much you might enjoy the role. While not wanting to stray into career advice, a decision to change may be based on: better prospects elsewhere; change of career path; suiting personal requirements such as distance to work or hours worked; or time out of the workforce. Most are likely to have some gripe with the existing role too. The reality is, in practice, nuanced. The current job is probably not so bad and the alternative not so good. Britain is discovering that the decision to leave the European Union is much more complex and less satisfying than the idea at the time.
Equity markets have pulled back to around the level at the start of the year. They have provided very solid returns for most of the past decade. On a three-year basis to end-October 2018, the hedged MSCI All Country index is up 8 per cent a year and more if unhedged. This is by any measure a very good outcome. Should one bank these gains (even within this downturn), take the “gap year” or change direction?
Portfolio options
Consider the decision tree in the career choice analogy. If there is a view that this is a resetting of expectations based on a changing valuation and earnings outlook, it’s the better prospects elsewhere that should win out. That implies recasting the equity portfolio towards different stocks and fund managers that are adapted to the new outlook (rather than holding out on the assumption past conditions will return), but basically sticking with the plan or even adding to growth assets.
A more significant change would be to reduce the equity weight as well as its contents, while also electing to reallocate to another asset class. The two that might be considered are, however, under their own cloud. Fixed income, given interest rates, is hardly compelling and alternative investments (hedge funds and the like) have had a less than stellar record in recent years. In this environment a bit more cash than normal may be an acceptable option.
Then there is the tradeoff to suit requirements. It requires a compromise as it likely does in a job. Forgo capital gains to achieve an income level? Elect to grow the portfolio and accept the volatility? In practice, many investors struggle to stay with this path, always flirting with other options and a sense of missing out.
Finally, take time out and leave the investment market entirely. The outcome is cash-like returns. History shows that being in only cash for more than a year has not been a good decision, there is always something else that is better. The gap year applies, and one must concede you can’t time the entry back in as the market (equity and job) is not that predictable.
This equity sell-off has been vigorous, at around 8-9 per cent over the past three months, and total portfolio outcomes have not been redeemed by fixed income or currency as has been the case in many such past events. If this has proven to be so troublesome, it is probable that the investment portfolio had too high an allocation to growth assets and within that, a growth-style bias. For those who stuck it out in underperforming managers or stocks that are conversely now holding up better, it is some vindication for staying the course.