Things often change very quickly

THINGS OFTEN CHANGE VERY QUICKLY

South Africa’s stock exchange, the JSE, had a spectacular month last month, delivering a monthly gain of 19.6% when measured in US Dollars, outperforming the majority of stock exchanges around the world.  Part of the return is due to a weakening in the Dollar but even when measured in Rand terms the JSE finished the month 12.3% higher.  This one-month return is greater than the accumulative return that would have been received by investing in cash over the last two years.  What’s even more telling is that over the last two months the JSE has appreciated a whopping 17.4%.  This serves as a constant reminder how quickly things change, so in this month’s Financial View, we once again present why one has to stick to your plan and the basics of investing.

Investors have had a very difficult year.  The war in the Ukraine has resulted in shortages of oil and gas, this has caused prices to rise and contributed to widespread inflation, mainly impacting the developed economies of the world.  In order to reduce the inflation, Central Bankers around the world have been forced to hike interest rates.  The impact of the rate hikes raised fears of a future recession causing a large amount of negative sentiment.  Investment decisions are generally driven by sentiment, often simplified as fear and greed.  The negative sentiment (“fear”) often causes people to flee out of growth assets, like equities, that have diminished in value, with investors preferring the safe haven and certainty of sitting in cash.  There is plenty of evidence that this is one of the worst investment decisions an investor can make, yet it is a mistake that is often repeated as the human psyche has a strong aversion to losses, even if just over the short-term.  The reason that this is such a big mistake is that when the stock market recovers, it recovers very quickly.  It is a near impossibility to forecast the exact moment that the recovery will begin.

One of the main reasons behind investing is for your capital keep up with or to outperform inflation and to increase wealth.  To increase wealth, one needs to invest in assets that will deliver returns that will outperform inflation.  Equities as an asset class have proven over the long term to be the most consistent beaters of inflation.  This is because companies can react to embedded inflation by changing their selling prices, rationalising costs or output.  The problem with equities is that they are subject to sentiment and thus these returns are volatile and are not delivered in a straight line.

The above table shows the annual returns of the major South African asset classes.  The STeFI Call Deposit rate is the proxy for cash.  The STeFI (Alexander Forbes Short Term Fixed Interest Index) is a recognised benchmark of the returns earned in the South African money market.  The money market consists of cash-like investments with a maturity of under one year.  One can see that the returns are the most consistent and have floated in a very narrow band between 4% and 7%.  It means that the best outcome an investor can realistically expect to receive sitting in cash is 7%, which is below the current level of inflation.  If you pay tax on your interest income your after-tax returns could be even lower, with a 30% tax rate your after-tax return would be approximately 5%.

The All Share Index (ALSI) has delivered a noticeably different pattern of returns.  The last 10 years have been one of the worst periods for the South African investor with “the lost decade” of corruption decimating our economy and our State Owned Enterprises.  In this period equity investors have only ever lost money once, in 2018.  Every other year the equity investor still received positive returns, including 2020, the year of Covid and the hard lockdown.  What is also telling is that over the 10 year period, 4 of the years delivered calendar returns of more than 20%.  It is not comfortable being an equity investor due to the emotional toil that the stock market inflicts on you, but you are rewarded for your turmoil with greater returns.

Some basic investing principles to stick to avoid switching lanes into the slow lane:

• The investment term should determine asset allocation – the longer the term, the greater the allocation to growth assets like equities
• As the end of the investment term approaches consider reducing risk and introducing a greater level of capital preservation into your portfolio. There is a trade off between growth and protection, you cannot have both.  The more protection you want the lower level of risk you can accept.
• Portfolios always needs to be diversified. Even if invested only in equities there should be a blend of companies and industries within the portfolio.  It is also critical to get offshore exposure to eliminate concentration on the prospects of a single economy.
• When faced with the pain of losses consider whether negative share price movements indicate a permanent impairment of the revenues of the underlying company or just a change in sentiment. It is often worth remembering Warren Buffett’s quote, “be fearful when others are greedy, and greedy when others are fearful.”
• Contribute on a monthly basis and benefit from rand cost averaging.
• Don’t stop because markets are down, continue through the dips as this is where you are buying good value and add most to your returns.
• Stay the course. Often doing less results in more.

These are just some of the most basic investing principles.  Principles that are proven over and over again.  Do it for as long as possible, acquire a large balance, make sure you are invested in the right asset classes and have the correct risk exposure.  Then when you are older you will sit back and see the benefits of compounding returns.