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Three important investment lessons to take from 2016

 
Kevin Murphy
Children being taught a lesson at school
Trump and Brexit stole the headlines in 2016 and supposedly moved markets but what lessons can investors learn from how stockmarkets performed? (Source: Getty)

Did anybody anywhere in the world put an accumulator bet on the UK voting to leave the European Union, Donald Trump winning the US presidential election and Leicester City winning the Premier League?

The bookmakers believe not and you’d think they might have noticed – after all, these events were considered so unlikely that just a £1 bet placed at the start of 2016 on all three occurring would have netted £3,000,000.

The Brexit and Trump effect

At this end of the year, of course, while those who foresaw Leicester City as Premiership champions remain thin on the ground, there is no shortage of commentators who will tell you they predicted Brexit or Trump or both.

And yet, here’s an interesting question – even if you had known the result of the EU referendum and the US election in advance and with absolute certainty, what good would it have done you as an investor?

No, nipping down the bookies is not an option in this game – we said ‘as an investor’.

And at the start of the year, if someone had told you the biggest smiles on the mornings of 24 June and 9 November would belong to Nigel Farage and Donald Trump, the only equities you might have even thought about buying were manufacturers of tinned goods and shotguns. And maybe a property company leasing remote caves in Wales.

What you are highly unlikely to have done, we would suggest, is to have piled into equities across the board on the basis the market would take just a couple of weeks to bounce back from its post-referendum losses, and not even a day to account for Trump’s impending residency in the White House, before resuming its march towards all-time highs.

Three investment lessons learnt in 2016

As we have observed on numerous occasions this year – in articles such as Poll position and Brexit’s double illustration – macroeconomic forecasting with any degree of accuracy and consistency is very difficult, but for our first investment lesson to take from 2016 we will go one step further:

1. Macroeconomic forecasting is not only very difficult, it frequently doesn’t help as the market may move totally contrary to what you believe is appropriate.

The US president-elect also features in our second lesson because, say what you like about Trump, he has been great for value investors, right? Wrong.

Here on The Value Perspective, we know what you are thinking – Trump has said he is going to spend money on infrastructure, which means borrowing a lot, which means bond yields go up, which leads to inflation, which for a variety of reasons tends to be good news for value.

So at least runs the narrative – and so inevitably run a slew of media headlines – and there is only one little problem. The narrative does not fit the facts.

If you look at the numbers, you will see that value started outperforming in February – months before Trump was even confirmed as the Republican Party’s nominee, let alone as president.

The Trump explanation for value doing well is an example of ‘narrative fallacy’, which can also translate as ‘people like a bit of story’.

The reality, however, is much more prosaic – value investing and value investments had underperformed for so long and become so cheap that their discount to momentum had grown too great for the wider market to ignore.

People may like to be able to point to a catalyst for something happening but that does not mean one exists.

Even with 10 months of hindsight, we are unable to pick out a particular number on a particular day and say, there, that is why value started to outperform – and the same is true for any number of big market turning points.

Lesson two then is:

2. Don’t look for catalysts and ignore any narrative – just focus on the numbers.

In addition to unpredictable events and value’s resurgence, a third big investment theme of 2016 has been the market’s obsession with supposedly ‘safe’ and ‘stable’ equities.

As we have noted this year, in articles such as No defence, this has seen the prices of large companies with historically low volatility – the so-called ‘bond proxies’ – bid up to what would appear distinctly unsafe and unstable levels.

And that is rather the point. In investment, there are no equities that are always safe or always risky – only equities that are too cheap or too expensive.

So a business could have the most volatile earnings stream in the world, but if you buy it at a 90% discount to fair value you are giving yourself a very good chance of making money from the investment.

In the same way, you could identify the business that boasts the most stable earnings stream in history and yet, if you pay 10 times what it is worth, you are highly unlikely to make money – indeed, you are more likely to end up losing money.

To us, that is the definition of risk and it has nothing to do with the supposed predictability and stability of an asset – only the price you pay for it.

And so what was widely perceived to be safe in the summer of 2016 – for example, tobacco businesses, beverage companies, utilities and real estate investment trusts – have generally seen their share prices fall in absolute terms.

Meanwhile, supposedly risky banks, retailers and more cyclical businesses have broadly seen their share prices increase in absolute terms over the same period.

So our third and final lesson of 2016 is:

3. Safety stems from the price you pay, not the underlying dynamics of the businesses you buy.

We hope visitors to The Value Perspective will find all three instructive although history suggests the wider market may well have forgotten them by this time next year.

  • Kevin Murphy is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.

Important Information: The views and opinions contained herein are those of Kevin Murphy, Fund Manager, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

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