Five steps forward and one step back
At a CIO Conversation Dinner recently, I had an interesting discussion during the post-presentation drinks. The expression ‘five steps forward and one step back’ (+5, -1) was coined. I think that is a fantastic subject for an Investment Matters article (and I thank the gentleman from whom I borrowed it).
What it means
The expression speaks to the volatility that occurs in equity markets. Markets don’t rise in a linear fashion, and corrections (and even greater falls, as was the case in the GFC) can and do occur.
Source: IRESS, First Samuel
It is important to recognize that steps back do occur. But to then put them into a longer-term context. The red circle in the graph below is the graph above.
Source: IRESS, First Samuel
After a period of strong performance from the market - and even stronger performance for our clients' equity portfolios - it can be easy to get a little complacent. Or to consider rises to be the norm, and thus be surprised or concerned about a correction.
But steps back – or corrections - do occur.
We do not have any way to predict when the next one will be. However, after a number of steps forward recently, a correction sooner rather than later should not be unexpected.
We are different to the market
As I am sure you are aware, your Investment Team genuinely invests on a 3+ year horizon. Your equity portfolio also has a very different makeup than that of the market.
Over that time period, we aim for a strong capital gain (but we don’t get it right 100% of the time). It might be that the market suddenly, or over a preceding period of time, recognises the value in the company. Or a takeover offer is made as someone outside the market recognises the value.
Sometimes it takes a shorter period than 3 years for an investment to realise its potential. And sometimes it takes longer. We can not control timing. It is infrequently 3 years exactly.
Your portfolio contains investments that were bought at different times. And their value will usually be realised at different times. Sometimes, quite inexplicably, they can be realised in a wave.
So, in summary, the +5, -1 for your equity investments will not be perfectly correlated to the market’s forward and back steps.
That said, a correction in the market is likely to have a dampening effect on all shares, including those you own. The magnitude might not be as great, however – especially given you have a portfolio with a lower P/E than the market.
Not always +5, -1
It won’t necessarily always be +5, -1. Sometimes it can be +10, -2. Or whatever pattern really. It is really just an analogy. Importantly, the thing that we see is, over time, there are more steps forward than back, i.e. your wealth grows.
Actually an opportunity
It may seem counter-intuitive, but market corrections are actually welcomed by your Investment Team. During these times, more opportunities present at favourable valuations. Acquiring these investments sets up your portfolio to achieve stronger performance in the years that follow the correction.
Your portfolio's neutral asset allocation will have been set when you first invested, noting factors including your individual desire for return and tolerance for volatility. However, if you do worry about a step back – a correction to your equity portfolio – please call your First Samuel strategist. Also, if you have changes, such as your future cash flow needs, also please call your First Samuel strategist. That is what we are here for, and they can work with you to ensure the most appropriate weight of equities, as compared to less volatile asset classes such as income or property securities.
Five steps forward and one step back is a useful way to look at the bigger picture of your equity investments. Corrections can and do occur. And after a recent period in which we have enjoyed a number of steps forward, a step back sooner rather than later should not be unexpected.