The world is an uncertain place at the moment. The deadline for the United Kingdom’s withdrawal from the EU is edging closer without a deal yet in place. There is also the ongoing threat of an all-out trade war breaking out. While nobody is sure what the future will bring, the question on many people’s minds is – is now a good time to be invested in the stock market?
The short answer
We believe that investing should be for the long term, and that markets and the economy have a tendency to rise over time. For investors, this should mean a return on investment for people who can ride out the ups and downs along the way – a reward for the extra risk they’re taking.
A key aspect of our investment philosophy is to let time do the heavy lifting for us – basing our investment decisions on the fundamentals rather than trying to time the markets or second-guess rises and falls in prices.
Volatile share prices
This year has seen the return of volatility to most major stock markets after what was an unusually calm 2017, and arguably this higher volatility is a sign of a more healthy equity market. Whilst volatility is often associated with falling markets, it is actually a measure of uncertainty and variability – it can often provide as much opportunity as it does threat.
When you think about investing in broad terms, we often talk about higher risk offering the potential for higher returns – that is, investors in riskier and more volatile assets tend to receive a ‘risk premium’. This is entirely natural in markets, and markets carry a lot of uncertainty, including known unknowns and unknown unknowns. That is why equities, as a relatively high-risk asset class, should be volatile – unusually low volatility concerns us, as it can be a sign that markets are complacent.
There are rallies and sell-offs throughout history
Throughout history we have seen periods of extreme volatility – there have been rallies and sell-offs time and time again for a variety of reasons. The current level of volatility is actually still at the lower end of the long-term range. This graph shows global equity returns alongside volatility levels over the last 20 years.
Global stock market returns and volatility levels
With long-term investing we can expect cycles – periods of falling prices followed by a recovery. A key to successful investing is being comfortable knowing that there will be falls as well as rises in the market.
Many people will remember the dotcom bubble of 2001 and the global financial crisis of 2007. The effects of these events on the UK stock market are shown in the graph below, which compares the returns from holding cash in a savings account with investing in UK equities and reinvesting income over the last 30 years:
UK stock market and cash returns
Both crashes caused big losses for investors – these are represented by the two dips in the red line. However, as the line rises we see recovery and a return to profitability for those who stayed invested for the long-term. The numbers show that it took six years for the stock market to recover after the dotcom crash, and four years and four months after the global financial crisis.
Markets tend to rise over time
Although stock markets are cyclical in nature and prone to volatility, markets and wider economies have a tendency to rise over time. This applies to everything from share prices and earnings to wages and the price of household goods.
The graph shows that stock market returns stayed above that of cash even with the sell-offs of 2001 and 2007 (although we must remember that past performance isn’t a reliable indicator of future performance).
Investing is for the long term
At Tilney we believe that investing requires patience and taking a long-term view. When we make investment decisions we ignore ‘market noise’. Instead, we focus on the fundamentals and changes in value – these are the key drivers of long-term returns and they are possible to forecast with a degree of accuracy.
On the other hand, short-term returns are driven by changes in valuation and investor sentiment. These are impossible to forecast consistently, and trying to time the markets can also mean potentially locking in losses and missing out on gains.
This is why we do not try to time the markets or make short-term trades. While we may sometimes make marginal tactical calls if opportunities or risks present themselves, we always maintain longer-term strategic asset models.
The effects of compounding
Compounding is one of the reasons long-term investing has the potential to give such great returns. This is the snowballing effect of your returns generating more returns. Albert Einstein reportedly called it “the eighth wonder of the world.”
In the stock markets, compounding is usually a result of reinvesting dividend income. Companies are collectively owned by their shareholders, and their board members may agree to pay investors their share of the profits through a dividend.
Dividend-paying shares are a staple of most income-seeking investors’ portfolios, but when the income is reinvested we can see a significant increase in total return over time. This makes them ideal for investors who are seeking growth – especially as a stable and growing dividend is seen as a sign of good corporate governance.
To see the effects of dividends, this graph compares the total returns from the UK stock market over 30 years, both with and without reinvested income. If you had invested £1,000 in 1986 and reinvested all of your dividend payments back into the stock market, your total return would be £14,250. If you had taken out a regular income your final portfolio value would be £4,150 – more than £10,000 less.
UK stock market returns, with and without reinvesting income
The risk of keeping your money in cash
When people feel nervous about investing – perhaps due to political uncertainty or volatility in the stock market – a common reaction is to sell their investments and keep their money in cash. Cash is seen as a ‘safe’ asset, but it does leave investors open to the risk of inflation.
Inflation is known as the silent killer, and it erodes the buying power of your savings over time. Your account balance doesn’t change, but you can buy less with your money. Inflation (measured by the Retail Prices Index) is currently sitting at 3.5%, and forecasts are for this inflationary environment to continue for the foreseeable future due to sterling weakness in the wake of the Brexit referendum.
This graph shows the effects of inflation over the last 30 years. If you had £1 in 1987 and left it untouched you would still have £1 today. However, taking into account increasing prices over the last 30 years, your £1 would only actually give you 35p of spending power in today’s money:
Purchasing power of £1, adjusted for inflation
Although markets have been volatile and there remains uncertainty over the global political future, we see no reason not to be invested in the stock market in the current economic climate. We are confident that good returns can be found for investors who are comfortable taking a long-term view and riding out any market volatility.
At any moment in time there will always be reasons not to invest and scenarios to worry about. However, we must remember that every period of time spent out of the stock markets is a period of time potentially missing out on returns. As we have seen, these periods of good performance tend to provide a positive overall return over the long term, even with falls in the market along the way.
So if you have a long time horizon and can accept the fact that markets tend to rise and fall along the way, we believe that now is as good a time as any for you to be invested in the stock market.
For more information or if you have questions about your investments, please speak to your usual Tilney contact or get in touch by calling 020 7189 2400, emailing email@example.com or requesting a call back.
This article was previously published on Tilney prior to the launch of Evelyn Partners.