Featured Articles

The Wisdom of Ben Graham

Market setbacks are painful for those already invested and they offer opportunity for those who may have spare resources. The number one question that investment advisors probably get asked is: when is the right time?

Of course, as we can't tell the future few of us know. There are some familiar signs of market tops and bottoms, but they are never precise or consistent enough to be reliable. In our Weekly Newsletter, we've previously highlighted Capitulation as an excellent timing indicator of market bottoms. And it certainly helped us in GillenMarkets in the recent coronavirus-led sharp sell-off in markets as we outlined in a separate Featured Article titled Capitulation Suggests a Possible Bottom in Markets written on 25th March 2020 (just 2 days after the actual bottom at that time).

There are rare occasions, never comfortable ones, where there is a complete absence of buyers for whatever reason. With the coronavirus it was the sudden realisation of a global economic lock-down and the likely impact on business.

But due to the liquidity in markets sellers keep at it until the buyers emerge, at which time in all likelihood you have the bottom, or soon afterwards. Capitulation is a measurable event.

We say 'in all likelihood' because of the 17 capitulation events that have occurred in US equity markets since 1953 (at the time of writing) markets recovered 26% on average the following year with a loss after 12 months on just one occasion.

Market Timing PhotoNothing is guaranteed in markets as we know, but we would prefer to be armed with those objective facts. If the sellers have sold what they were trying to sell, then it makes sense that the bottom is probably in. It's the reason why markets can discount bad news much quicker than most think possible.

I've always been struck by the great wisdom of Ben Graham, author of The Intelligent Investor where he said, 'an investor can take advantage of the wide and recurring fluctuations in stock prices by way of timing or by way of pricing'.

By 'timing' Graham meant trying to time your entry into and exit from markets. Of course, everyone would like to be out of bear markets and only in for the uptrends. Graham always argued that trying to time markets like that was speculation, not investment.

By 'pricing' Graham is referring to the fact that you can price an asset and if it offers the prospect of a reasonable return with minimal risks then you can make an informed investment decision. This approach keeps you in markets, but in specific investments that fulfil those criteria.

The latter approach has the advantage of not needing to time markets, which actually eliminates the risk that you will be left out of markets when they rally. As markets make upward progress in the long-term that's a principal risk.

And while the value of your investments goes down with markets when they decline, that's not the same as suffering permanent losses. When markets recover, as they inevitably do, and assuming your investments are sound, they, too, should recover in value and grow to reflect the potential for growth in earnings at the companies over the medium to long-term.

It has always struck us that this latter approach is the only true way to invest. Volatility is a fact of life in markets and can't be willed away.

Since the Global Financial Crisis and with some amendments to regulations, the investment community has tried to dampen volatility for retail clients with the introduction of absolute return funds. They promise positive returns without much volatility.

Our own research has shown that such funds add no value over and above a traditional lower cost, and probably lower risk, mixed asset portfolio made up of equities (for higher returns) and cash and bonds (to cover all the major economic risks).

Absolute return funds are not a new asset class, and all they appear to do is extract a large part of the return that might otherwise accrue to the investor. Structured products that offer guarantees are an even bigger waste of money, in our view. Click the links for our previous Featured Articles on Absolute Return & Hedge Funds and Guaranteed Structured products

What an investor really needs is a plan to navigate all market conditions. The regular investor, and that includes someone savings into a pension fund, should welcome these battered markets. Additional savings can be put to work at much improved values.

The lump-sum investor, the person who is unlikely to be in a position to add meaningful further to their savings programme, has the trickier task as he/she doesn't get to go again. The solution is to first make sure that you have time, and a 5-year commitment carries high odds of success.

With time on your side you can simply invest the lump-sum now if you feel you are obtaining sufficient value to underpin reasonable returns on a 5-year view (the Ben Graham approach). Or you can average in over time.

Should you decide to average in over some timeline you should place objective rules in place at the outset. Commit to averaging in at set intervals and by all means speed up the commitments if markets decline further. This plan avoids the scenario where you are waiting for market setbacks, but they keep rallying higher.

Rory Gillen
Founder, GillenMarkets
11th May 2020