Investors must understand two rules for successful investment:
- The difference between price and value
- Patience usually linked / associated with time horizon
The reference to simple is buying low and selling high, which is not that easy and often requires patience. The difficulty is a function of our faulty evolutionary “wiring”, which leads to emotive and instinctive behaviour finance errors well researched and documented under the subject Investor Behavioural Finance. Investors and prospective investors will do well to study behavioural finance in understanding their own and other investor’s behaviour.
The movie the Big Short portrays how Dr. Murray over comes his own doubts and negative market sentiment to bet against the “herd” during the Great Financial Crisis (GFC). He effectively suspends withdrawals from the fund he is managing to protect his investors against themselves from emotive selling. Needless to say this made him very unpopular until he was proven right and he was rewarded with massive returns for himself and his investors. The point is even the professional guys are affected by sentiment and their own behavioural biases.
With the above as backdrop I would like to look at a world post the GCF. Central Bankers globally unleashed unconventional unprecedented amounts of accommodative stimulus on world markets in the form of zero interest rate policy (ZIRP) and quantitative easing (QE), which is still ongoing today 7 years later.
Investment bankers and astute investors used the cheap money to speculate on stock markets driving indices to new highs and making a lot of money; although this was not the purpose of ZIRP & QE, which was primarily to drive growth, the recovery in asset prices did restore confidence in the global financial system and fuelled the animal spirits of investors known as the wealth affect.
Where we are today and what are the opportunities / risks?
Generally speaking (i.e. the herd) has forgotten the rules. Global Stock Markets have been driven up by a narrow band of shares where price no longer matters. Investors are seemingly willing to pay any price for good quality companies irrespective of their underlying intrinsic value, while ignoring or selling lower quality cyclical businesses at price often well below fundamental value. This is the risk and opportunity. To exploit it investors will need to remember rule 2, which unfortunately the herd has long forgotten.
Mcomm, CFP®, HdipTax
T. 021-851 3746