Shares – is now the right time?

An article by Bob Schroder

I used to have most of my assets in shares. It was only by pure luck that I managed to get out of most of my shares before “The Crash of ‘08”, but that’s another story!

I read lots, I think and I try to work out what will happen in the market. The honest stock broker, when asked what the market will do in the short term will tell you that it will either rise or fall – or perhaps remain pretty steady. If brokers were particularly good at predicting market changes then they’d all be rich and wouldn’t need to earn a living from broking!

Never-the-less I’m going to have a bit of a go at making some predictions – not short term ones, because I think that that is a waste of time, but more medium term ones. Just don’t hold me to them!

Firstly, I think that it is important to recognise a few simple facts:

• The share market performs about as well over a long period of time as other classes of investment with the same risk level – if it didn’t perform as well then no-one would invest in shares, they would invest in the other things and share prices would fall through lack of demand thus increasing the return on investment from shares until it matched other investments at similar risk levels. The reverse holds true.
• The share market is more volatile than other forms of investment – especially property – primarily, I believe, because you can make a decision to buy or sell and have carried through that decision electronically over the Internet in a matter of seconds. Property takes longer to affect a transaction. This volatility can be both good and bad. It means that someone who can, and does, predict a short term swing in the market can make large amounts of money quickly. The reverse is also true.
• Shares are often affected by investor sentiment. Apart from the obvious day-to-day swings in the market due to the latest newsflashes there is a tendency for markets to follow patterns which, at their root are related to investor confidence. When shares are doing well, investors tend to purchase shares at higher and higher prices in the belief that they will continue to rise. This in turn sends the price/earnings ratio (PER) of the shares higher. Usually PERs in the mid teens are about right and PERs will go from there until they reach the low 20s. A ‘correction’ will happen and prices will drop a little until PERs return to ‘normal’ levels – sometimes below ‘normal’. Everyone who buys shares at PERs that are above ‘normal’ is betting that they can make money on the shares before the market goes down.
• When a company goes bad your shares become worthless – I took a bath on ABC Learning and my entire investment in this company is worth zero now! Tangible investments, such as property always retain at least some value.

There are a few interesting things that I have learned about market crashes too:

• The market takes a time to bottom out and still more time to recover. I have looked at the data for the 13 big bear markets in the USA over the past 100 years. If we ignore the oddest data points in each category then the data look similar and show that there is usually a 32% decline in the market from peak to trough over a period of 16 months and the market takes about 24 months to recover.
• During the bear market process there are usually a number of points at which the market will look like it is recovering. These are known as ‘bear market rallies’ and represent small rallies that are inevitably followed by losses that take the market to a new low. There seem to be between 5-7 of these rallies during a major bear market before the market actually bottoms out.

How do I analyse this information?

• I believe that we have had about 2 bear market rallies in this current cycle. This means that I expect that we are still going down.
• The major bear market started in October 2008 and, on the averages data will take about 16 months to bottom out. This would take us to mid February 2010.

How do I intend to use this information?

• I’m going to wait until February 2010 to start reinvesting in the share market.
• In the meantime, I’ll invest wisely in property.
• I will eventually change my investment portfolio split so that I am more balanced between property and shares – with an accent on property for the foreseeable future.
• As I decide to reinvest some of my portfolio in shares I will do so slowly and with caution over a period of time. If the market takes up to 24 months to recover to its previous level then there is no need to hurry, there is more need to be sure!

There are people with vested interests out there who are busy telling us in all markets and at all times that we should be getting back into shares. The latest ‘good news pedlar’ produced a beautiful graph that was, on the surface, highly convincing ...

... until you realise that each of the bars represent one year and that, on the strength of this graph the market is set for a further year of negative growth if you follow the very trend that they are recommending you follow! Watch out for the sunshine merchants that do not have anything to demonstrate a major underpinning of their strategies.