If you listen to radio news every day or watch regular television bulletins you might think that what the JSE does every day is important. News readers seem to be obsessed with telling everyone how the All Share Index or Top 40 have performed in the last few hours.
This information is, however, largely meaningless. And it is particularly meaningless to anyone who considers themselves a long term investor.
On any given day, the JSE is almost as likely to fall as it is to rise. Analysis done by Old Mutual’s MacroSolutions boutique has found that, on a day-to-day basis, there is a 45% chance that the market will deliver a negative return.
This doesn’t change much over a week. On a rolling basis, there is a 43% chance that the JSE will go down over any week, which is still largely random.
There is therefore no real value to be gained by knowing the daily, or even weekly, movements of the index. It will go up and it will go down. That is the nature of the stock market, which is inherently volatile in the short term.
Working over time
What is important to any genuine investor is how the market performs over much longer periods. This is illustrated in the graph below.
What is far more significant is that over any five-year or 10-year period, the JSE has never delivered a negative return. And over the very long term, the performance of the stock market is also far superior to any other type of investment.
The graphic below shows the performance of the three major local asset classes over nearly nine decades. The superiority of the stock market is obvious.
In order to earn these returns, however, you have to accept the short term risks. As Fernando Durrell, portfolio manager with Sanlam Investments, explained at the Glacier Investment Summit in Stellenbosch, this is not a question of timing. It is about patience.
In the graph below, the dark blue line shows the return someone would have received from the FTSE/JSE All Share Swix Index if they remained invested over the full period. The variations either way illustrate what the result would be of missing either just a few of the best or worst days of market performance.
Just missing the single best day of performance over these 24 years would mean that an investor would see only 92.8% of the return. That is a substantial reduction for missing just one trading period out of the 6 000-odd days in this sample.
“If you missed the best five days, your portfolio would be 30% lower, and if you missed the 10 best days it would be close to 45% lower,” Durrell noted. “That talks to being in the market.
“But on the flip side, suppose you could avoid the worst day, your portfolio would have been 13% better,” he added. “If you missed the worst five days you would have 53% more and missing the worst 10 days would mean you would have 110% greater.”
The question this raises, however, is whether you could time the market to use this to your advantage.
“There are reasons for being in as well as out of the market,” Durrell said.
“The problem is that your best day and your worst day are frequently separated by a day, so you have to be close to clairvoyant to predict accurately when to get in and when to get out.”
Can you tell the future?
This is illustrated in the graphic below. The vertical lines above the horizontal indicate the best days of performance on the JSE over this period. Those below, illustrate the worst days.
It is clear that the largest ups and downs are frequently grouped together. Devising a strategy that would see you in the market for the best days and out of the market for the worst days is therefore impossible.
It makes far more sense to use a strategy that allows you to capture as much of the upside as you can on the good days, while reducing the risk on the downside. That is precisely what a good balanced fund should do – give you exposure to the market by having a high weighting to stocks, but balancing that with other asset classes like bonds and cash, which offer downside protection.
“What you really need to do is have a diversified portfolio that is able to manage the risk,” says Durrell. “That is something that gives you exposure to downside risk management and allows you to participate in the upside.”
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