Time horizons are important in investing. They determine our goals, actions, and behaviours. Most investors we meet articulate longer term time horizons, usually multiple years or even decades.
This is because they are many years away from needing the fruits of their savings, usually upon retirement or some other life event.
Fund managers are often the same, articulating long-term investment approaches that seek to maximise the probability of a successful outcome over many years or decades. Indeed, in recent times the average holding period we have for the equities we invest in has been between 7 and 10 years. To put this in perspective, on average, what we buy today we will own until somewhere between the years 2029 and 2032.
Investors and fund managers do this as it is much easier to plan around long-term goals than it is shorter time horizons. Calculating an acceptable income on retirement and working back gives a clear indication of the types of assets, and their associated risks, that will need to be owned to deliver it. Equally, as a fund manager knowing our goal is to deliver investment performance over the long term clarifies the types of business we need to own (in our case sustainable businesses) and the behaviours we need to adopt to succeed. So, if we have long-term goals, it becomes clearer as an investor what needs to be done to deliver them, and as a fund manager the kind of businesses and behaviours we need to focus on. So far so good!
Of course, it is not that simple. The problem with time horizons is they can contract based on emotive characteristics such as stress and fear. For example, no one being chased by a bear is thinking how to save for their retirement; they are thinking ‘how do I get out of this alive!’ It is the same with investing. Periods of share price falls and underperformance are emotive, often creating the fear of further losses. Under these circumstances time horizons contract, and the mentality of investing changes from what do I need to do to be successful in the long term, to what do I have to do today to survive.
Unfortunately, it is impossible to separate what we do day-to-day from long-term goals. As the saying goes, what we do each day is what we do in life. There is no delivery of long-term goals without daily activities which reinforce and deliver them. It is the same in investing; there will be no long-term success if the day-by-day actions we take don’t reinforce those goals.
What we are seeing today is a powerful contraction in the time horizon of investors and markets. The narrative has shifted from how we invest to make the world cleaner, healthier, safer, and more inclusive, to wondering what next month’s inflation number will be. To be clear, we are equally keen to know what the next inflation number will be, but supplanting long-term goals with short-term fears is rarely a successful investment strategy. To the extent there are important and difficult problems to solve today both economically and societally, and that they may take some time to resolve, it seems likely to us that over time the world will decarbonise, technology will become more pervasive, and the treatment of many diseases without cure today will have been improved. It is a time to consciously extend time horizons in the face of emotions which are pushing the other way.
The 10/20/50 rule, revisited
Earlier this year we wrote about the 10/20/50 rule. Under the principle of ‘happiness is the difference between outcomes and expectations’, it is important to have expectations of what holding equity investments will be like, as this prepares and fortifies the owner. Under our rule of thumb, each year on average there will be a 10% fall in markets due to a headline grabbing but ultimately unimportant story, such as trade wars. Every five years there may be a 20% fall in equities due to a recession, itself a function of the normal economic cycle. Finally, every 10 years there will be a 50% fall in the value of equities due to a systematic issue which leads to a fundamental repricing of shares. The last example of this was the financial crisis of 2007/8, where over a period of 501 days the S&P 500, the US stock market, fell 56.8%. Each of these types of setbacks are part of the natural rhythm of markets, and ultimately are erased as economies continue to grow and evolve.
When we wrote about this previously, markets had corrected around 10%, and the debate was around whether there would be a recession. This was before Russia invaded Ukraine, and since then the consensus is that both growth and inflation will be worse than previously thought, taking some economies and markets, at least temporarily, into recession and bear market territory.
This construct is useful as it helps us understand what is priced into markets, and what we must believe in terms of future scenarios for markets to move either up or down. Under this approach, a regular recession is largely priced into equity markets now, and if we are entering into one then it is unlikely to move markets much further down. This view is likely predicated on inflation reducing over the coming months to a level that will not require more interventional central bank action than is already forecast. Should outcomes be better than this, then equity markets could perform well as the year progresses.
The question on the downside is what is the probability of this being a once in 10-year 50% correction? Under this scenario, inflation would continue to rise, perhaps because of the war in Ukraine, and central banks will have to raise interest rates even higher than expected or tolerate higher levels of inflation than in the past. Neither of these scenarios would be good for asset prices, even from today’s levels.
We can find highly experienced investors and economists who take both sides of this debate. Ed Yardeni, an experienced US economist and market strategist who was around when inflation was last an issue, is of the optimistic view that a combination of central bank action, productivity improvements and time will be bring inflation down without a hard recession or interest rate increases beyond current forecasts. If this is to be the case, his view would be equity markets have already adjusted and should make new highs next year. Anatole Kaletsky, of Gavekal research, who was also around in the 1970s when inflation was pervasive, is of the view that the sources of inflation, energy and food, are beyond the control of central banks as they are a function of sanctions and war, and that inflation will be higher for longer, forcing central banks to push interest rates even higher, undermining asset prices for some time to come.
Who is correct? No one knows in truth. And both views are subject to future events which could change the path of markets and economies materially again. In our view, and again expanding our time horizon, it seems unlikely the end point for businesses and industries we do and don’t invest in has changed materially when considering the decarbonisation, technology, and health trends. In the short term however, the outlook is unclear for us all.
The experience of managing money in recent months has reminded us of the skills required: it is 20% IQ and 80% EQ. It isn’t the ability to identify long-term goals and the actions that deliver them that defines success or failure – many people can do that. It is the ability to enact them day-to-day when emotions and feelings are urging us to act differently. As Mike Tyson famously said, everyone has a plan until they are punched in the face. This is most definitely a Mike Tyson kind of market.
Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.