The Money Managers | In the News

Despite the pleasing share market results of the last month we are still a long way below the valuations of eighteen months ago. Why couldn’t we see this downturn coming? It would be much easier if every bear market in shares was triggered by the same set of events. In 2001 we came to grips with a sharp downturn caused by the events of that tumultuous period. Experience has shown that planes flying into buildings may cause panic and set off a string of events, but markets recover. We know that because we have lived through it and can speak from experience.

Earlier bear markets were caused by credit or currency crises and we know that markets crashed, but they recovered. The problem is that this time it’s different; no planes flying into buildings, no currency or credit crisis in South East Asia, South America or Mexico; this is a whole new set of circumstances.

Institutions that have been around for longer than we can remember are failing. The very gates of the free market that has served us so well for so long are under siege. If only it was the same as one of the other bear markets in the past, we would feel more confident about the future. We may even be prepared to ride it out, but this time it’s different.

Media reports suggest that nothing other than the Great Depression compares to what we are going through. There are those who suggest that the risk and return characteristics of shares as an asset class will be different in future. We have to fundamentally adjust our investment philosophy!

Remember in the late 90’s when the dotcom boom was driving markets? Warren Buffett famously said that he could not understand how the prices of these stocks could be justified and if he didn’t understand it, he was not about to invest in it. He was roundly ridiculed by those fresh out of nappies who had ostensibly taken over the investment world. Well, the rest is history.

What truths will emerge from this round of financial crisis? Surely we have to learn something; otherwise all this pain and loss will have been in vain. “There are two times when people forget their investment principles: at the top of the market…, and at the bottom.”

There have been 31 bear markets in the last 100 years, each one followed by a recovery. The people who weathered the storms and reached their goals were the people who had the courage of their convictions. The principles of investment are not exciting or easy; but they are true.

While it may be true that the catalyst for this downturn in the World’s economy was a unique set of circumstances, we must realise that this will always be the case. The same set of events is unlikely to recur over and over to start the fall in world markets. Because we cannot rely on our own experience, having never experienced anything like this before, we must have faith.

Timothy Geitner, the US Treasury Secretary calls it confidence, but surely you can only have confidence if you have faith. Faith in the free market system and faith in a set of investment principles that have stood the test of time:

* Risk and return are related;
* Diversification is the antidote to uncertainty;
* Asset allocation is the principle determinant of return in a diversified portfolio; and
* Emotional corrosion must be avoided.

It may be time to go back to basics and undergo a revival of our faith in these principles.

We need faith, because faith instills confidence. As much as we may have a view on how markets will be affected in the future, it is best that we act on the basis of these principles not opinions on future market direction. Before 2008, there had been 30 bear markets over the last 100 years. The market has a 100% recovery record. Is the 31st bear market honestly going to be different?

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