Regardless of where in the world you live, investors tend to pay the most attention to the US stock market. And really, that’s sensible given that US listed companies make up around 60% of the world’s total stock market.
So with that in mind it’s no surprise that investors have felt the crash of 2022 very acutely.
Even after a bit of a late summer rally, the S&P 500 US stock market index finished the year down almost 20%. Many individual companies are down significantly more than that, even massive ones like Amazon (-50%), Microsoft (-28%) and Apple (-28%).
Some stock markets have fared better than this, and some even worse. In fact, a lot probably don’t even realise that the UK stock market has actually held up pretty well. The FTSE 100 ended 2022 up slightly.
Regardless of which market you follow the most closely, if you follow them at all you will have noticed that prices have generally fallen across the board. Now that this downturn has been going on for a number of months, the question is, have we hit bottom?
We get this question all the time from our clients. Some of them will be holding cash and waiting for the moment where they can swoop in at the perfect time and pick up investments when they’re going up, without having to worry about pesky volatility.
Look, if you’re a regular reader of our content you’ll know that we don’t mince words. If there’s a straight answer to a question, we’ll give it to you. If something in the industry has been designed to be needlessly complicated, we’ll lay it out simply.
So when it comes to the question of how to pick the bottom of a stock market crash or correction, trust us when we say, you can’t.
Anyone who tells you that they can pick the ultimate bottom of any cycle is lying to you. If it’s your friend or colleague, feel free to have a chuckle at their expense. If it’s a finance professional who’s trying to woo you to become their client, put away your wallet, put down the free coffee and get out of there.
The truth is that there’s no way to know when we’ve hit bottom until we’re looking back in the rear view mirror. With that said, there are steps that professional investment managers can take to narrow the range of potential outcomes.
We can’t pick the exact date of a market bottom, or a market top for that matter. No one can. There are simply too many variables and unknowns in the mix to be able to forecast that with any degree of certainty.
Spotting trends is different. We’re not trying to pick the exact date a certain event will occur, but rather we’re aiming to find the overall direction of a market or an asset.
You know we love to use examples, so let’s use one to show you what we mean by this. Right now the US tech sector has been the main driver of the crash in the S&P 500. That means that valuations are down across the board, and the ratios and metrics used by investment managers to analyse the companies have become more favourable.
A really simple example is the Price to Earnings ratio, or PE ratio. This is the number of years of company’s earnings it would take to purchase a share. So if Apple had Earnings Per Share (EPS) of $2 and the stock price was $10, the PE ratio would be 5.
10/2 = 5
PE ratios in tech are way higher than this in reality, right now Apple is around 22 and Tesla is over 60.
Why are we telling you all this? Because there are hundreds of different analysis points like this that investment managers use, and it means they can spot trends that guide investment decisions.
If all of these different ratios and numbers are beginning to show that a stock or a market is undervalued, it could be a sign that the bottom could be near. It won’t be exactly right, but skillful and knowledgeable investment managers can often get the broad overall trend correct, even if the timing isn’t exact.
They may miss the bottom by a few weeks or even a couple of months, but overall they are able to capture much of the upside when things turn.
So with that laid out, what should you do if you’re sitting on cash? There are two schools of thought here. Say you’ve got £300,000 burning a hole in your pocket, and you’re wondering whether now is a good time to get in.
You might be wondering whether now is a good time, whether you should wait longer to see if markets have further to fall. You might also be thinking about whether you should drip feed the cash in slowly over the next 6-12 months.
After all, everyone’s always talking about pound cost averaging. Putting a regular amount of money in each month. So if it works for cashflow? Surely it’s the best option for a lump as well, right?
Well, in short, no.
It can be tempting to dip your toe into the water. Say, by putting £50,000 of your £300,000 into the market. There are a couple of problems with that. Firstly, that cash isn’t just standing still, it’s going backwards.
Even during ‘normal’ times, inflation at 2-3% is eroding away the purchasing power of your money. With the current rates hitting double digits, the damage is much worse. By putting your money to work in an investment portfolio, you’re at least giving it the opportunity to grow above the rate of inflation.
But there’s an even bigger reason not to drip feed your existing cash in. The numbers suggest it’s likely to give you a worse long term return.
The reason for this is that the stock market goes up on more days than it goes down. Obviously this is over the long term and isn’t going to hold true for every period you look at, but when it comes to investing, we’re playing a numbers game.
From 1996 to 2016 the S&P 500 went up on a given day 53.3% of the time and down 46.7% of the time. From 2016 to 2021 the percentage of up days went up even more, to 54.9%.
That means that for every day you keep your money on the sidelines in cash, there’s potentially a 54.9% chance you miss out on gains.
Proprietary data from Coutts backs this up. They analysed the two strategies across a large number of their clients, finding that clients who contributed their investment in a single lump sum were better off than those who invested it in three separate tranches across multiple months.
Pound cost averaging is a great strategy for regular cash flow for the same reason. It makes more sense to put in cash each month as you get it, rather than saving it up as a lump sum and potentially missing out on gains in the interim.
If you’re sitting on cash and waiting for the perfect time to invest, think long and hard about what you’re gaining by waiting. Your cash is losing value every day and markets have tanked around the world, offering much better value than 12 months ago.
If you want to discuss your options to make sure you’re investing your cash in the right way, get in touch with us.