Are equities cheap or expensive?

Should I invest now or wait for greater falls? Are we heading into a recession? What about stagflation? Are equities cheap or expensive?

In response to these questions, consider this data.

*All returns quoted in USD, as at 31 August 2022. Source, Bloomberg

**Using the S&P Global Property index

And this graph, which shows the performance of global equities, from December 2000 to date:

Against this backdrop, it would be easy to argue that you should invest now providing two criteria could be satisfied:

1. You have a long enough time frame (traditionally 7 years or more)
2. You have the courage to remain invested for at least this time.

But the questions above really push for shorter term answers because they are driven by some of our most primary emotions. We want to know whether there will be a better time to invest, whether we expect further short-term market losses. In our minds, we imagine worst-case scenarios: 70s style inflation or a crash of the magnitude experienced during the global financial crisis.

There is natural fear of the unknown behind these questions because the reality is we are living in a period of high inflation, low growth, increased energy costs, labour market squeezes and rising interest rates, while a war between Russia and Ukraine rages on. Darker questions form at the periphery: will Putin take the nuclear option? Will China take the opportunity to invade Taiwan? Will civil unrest once again become prevalent in the US? How will Europeans heat their homes this winter?

I am periodically asked these questions. And, although we try to forecast what could happen if one of these scenarios panned out, the truth of the matter is we don’t know. None of us knows what the short term might bring. Most short-term forecasts predict that if there is a recession in the US, it will not be a protracted one. But we don’t know what is around the corner. Putin might take the nuclear option. China might very well invade Taiwan. And the flipside is also true. The US might get its soft landing, manufacturing data may continue to surprise on the upside and the energy crisis might be resolved. Against this, you must choose between a guaranteed loss of 8% per annum, or more considering inflation rates (as personal inflation figures vary greatly), and a possible temporary loss if money is invested.

You see, forecasting must necessarily be based on models. These use historical and current information to provide a range of probable outcomes, and they vary greatly – they could be mathematical or intuitive, fundamental or extremely complex. To do this, models use assumptions, aggregations and probabilities. For example, you can make assumptions about what would happen to markets if inflation in the UK were to drop to 6% next year. The goal would be to forecast options that would be closest to the real picture.

This is incredibly complex. Not only because of variables and data to be considered, but also because it seeks to attribute some degree of logic to human behaviour, in millions of consumers and market participants. Models need to predict how politicians, policy makers, consumers and investors would react in such a scenario. How can we predict what one of these key players will do, let alone billions of them? This is not to say forecasting does not have its place; it is an integral part of what our team of analysts do. To each scenario we attribute a series of probabilities based on research, data and experience, and indeed this points us in the right direction most of the time (hence our first quartile performance of late – for more information on this, please watch this short video).

But short-term forecasting tends to fail most frequently at times of pivotal change. That is why it is the long term and not the short term you should consider when investing and why the question of time frame is so important. That is also why the old adage of “time in the market, not timing the market” proves true. Put a different way, if we could set the clock forward and travel into the future seven years from now, I have no doubt we would emerge to see we are in the money – we made the right decision to invest. Because, regardless of what the next 18 months bring, in seven years equity markets will be higher than they are now, barring a catastrophe of proportions we have not yet considered.

However, it is not in our nature to ignore the short-term noise. And none of us have access to a time machine. This is why the question of composure or risk tolerance is so important. Are you able to remain composed when the headlines scream disaster?

The worst investment outcomes are caused by an old ally: fear. Fear is hard wired into our brains. Fear protected us from being eaten. We attribute probability to wildly improbable scenarios based on fear. In the investment world, fear can lead you to disinvest at the wrong time or stop you from investing at all, causing perpetual paralysis. Fear is the financial equivalent of shooting yourself in the foot.

Fear of the unknown has been and continues to be a far greater cost to many investors than the market drops they seek to avoid, especially now, with inflation rates soaring around the world. This is one of the many reasons why advice should be sought. You need to know how much risk you must take to meet your own personal goals and how much risk you can afford to take so as not to compromise your lifestyle. This is far more important than short-term market forecasting.