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13 Jun 2024 7:45
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  •   Home > News > Business > Features

    Testing Times for Popular Market Theories

    One of the hardest things about being an investor in the past 18 months was watching the failure of almost all the experts' most cherished concepts.

    Investment Research Group
    Investment Research Group
    Think of 'Flight to Safety', the concept that in bad times money would flow from highly geared growth shares to solid, conservative blue chip shares. When the market was imploding the way it did last year, there was nowhere to hide and all shares were sold down.

    Take Auckland International Airport, for example. A monopolistic provider of an essential service (at least to an island nation like NZ). Its share price went from over $3 in late 2007 to as low as $1.56 in December 2008. That is virtually a 50% drop from supposedly a super-safe share.

    The flaw in the Flight to Safety concept is that it involves the biggest and best companies on the share market. When the banking system began falling apart investors had to exit the share market quickly to accumulate cash and prepare for the hard economic times head. But which shares in their portfolio are the easiest to exit in vast quantities? Those that are the most liquid; that is the shares with the highest daily trading volumes, where there are plenty of buyers and sellers. And which shares have the highest trading volumes? It is these enormous, blue chip companies.

    So, in 2008 we began to see an extraordinary thing, the safest blue chips were falling faster than smaller, not so safe companies.

    Another popular phrase that advisors roll out in an emergency is 'Time in the Market', which you hear during market downturns to encourage investors not to fire them and to encourage everyone to wait for the next boom. In the past, this has worked as recessions have been short and sharp and were followed by extended bull markets. Sometimes, however, downturns can be drawn-out, grueling affairs such as the 24-year period following the 1929 crash or for the decade or more of stagflation during the 1970s.

    The jury is out on whether we are experiencing a rebound or merely a 'dead cat bounce' ahead of further economic and market declines, but either way there is a distinct possibility of an extended period of minimal growth. The fact is, the credit fuelled growth of the past five years is not going to be seen again for several years. Don't rely on the buy and hold strategy.

    Another truism that has shown it to be less than reliable of late has been 'invest in companies that make things'. These companies are relatively easy to understand and their financials quickly point to problems (inventories increasing, cash flow decreasing) and they have real assets (warehouses, manufacturing plant) that can be sold and presumably result in a partial return of capital to shareholders.

    But the problem with companies that make things is that they usually carry heavy overheads to make those things, and when sales fall below their breakeven costs, even the most venerable manufacturer can disappear in no time.

    The one truism we can repeat is that share markets and economies will always go up over time, but never smoothly because THEY WILL FLUCTUATE. Our planning should incorporate the fact that the only certainty about the share market is its head spinning volatility.

    © 2024 David McEwen, NZCity

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