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It is all too easy to follow the lead in the capital markets but the true investor follows the yield. Peter Webb gets back to basics
Price is what you pay, value is what you get. Common sense should tell you that if the price of something rises it gets less attractive, if it falls more attractive. Turn to the capital markets, however, and you could be mistaken that things operate in the other manner.
Speculate to accumulate
When you look at capital markets if a price rises, speculators view it as a good signal and buy; they do so because they are anticipating further rises. When the price falls they sell expecting it to fall further. If prices are going skyward then very often all reason goes out the window and speculators buy everything they can. This is often rationalised by an acknowledgment that the price is not realistic but it is still OK because they can offload the position ‘if the market cracks’. Somehow, all speculators believe they are better than the average player in this game of musical chairs. Unfortunately history tends to indicate otherwise. At the top, as the market turns, people get out. They exit the market not necessarily because they have a view on the market but simply because they can see the turn and others exposure, and want to save themselves. During the sell off liquidity often dries up and the poor liquidity impacts selling prices. This puts the whole thing into reverse and the whole market multiplies on the downside often over shooting in the opposite direction, especially where excess borrowing is used.
The long game
Long-term thinking is a luxury not available to the highly leveraged; they might not survive that long! There is no doubting why speculation is very popular because, as prices move, speculators can see an immediate return. Also due to the false sense of timing ability, a lot of speculators feel their downside risk is managed because they can cut for a loss quickly ‘ahead’ of further price falls.
If you are a true investor your focus should always be on yield. Your focus can be outright or implicit. By this I mean yield can be your focus whether the yield is opaquely measured by retained earnings or a more specific dividend payout. The upshot of this focus should be that when the yield is too poor you don’t buy. It can be frustrating holding spare cash for long periods of time but the markets can very often present new opportunities without warning and waiting for these rather than chasing the market is a good tactic.
Try not to concern yourself about capital growth or the present economic situation either. The yield and price people are willing to pay may ‘bump’ around a little bit but over time you if you have a strong yield backed up by a solid, then a consistent and growing underlying yield will ensure capital growth by default.
Get what you give
An often forgotten fact is that investors as a whole cannot get anything out of their investment except what the investment earns. Between now and when your investment expires you will only ever get out of it what it throws off in cash. You might outsmart the next person by buying low and selling high, but no money would leave the game when that happened; you would simply take out what they put in. The experience of the group wouldn’t have been affected at all, because its fate would still be tied to the underlying returns. Capital growth will always be self limiting because as the number of participants increase the price gets bid up. As the price increases the investment return will move towards zero. Either the yield on the investment needs to accelerate or the price of the asset needs to reduce.
History tells us the latter is more common. Soft landings are rare as asset prices often inflate to levels where a soft landing is not an option. You either face years of stagnation or, as people see below par returns, they cash in and set off a sharp downward movement in price.
It’s important to note that buying high- yielding stocks has also generally worked regardless of the underlying circumstances. Whether the economy was good or bad, cherry picking high-yielding stocks has always outperformed the market. It can be difficult to buy during a rough market period but if you can set aside the psychological problems with doing this, the rewards can be huge. If you are in for the long term there is nothing wrong with focusing on the underlying value of an asset rather than its market price. Asset prices have a tendency to fluctuate a lot over shorter periods but over longer periods they roughly mimic the true underlying value, always invest with this in mind.
If you are a longer term investor the best way to avoid paying an excessive price and to take advantage of potentially undervalued assets is simple, but not easy. Be fearful when others are greedy and greedy when others are fearful. Also adopt the right methodology and that is, that the market is there to serve you, rather than instruct you.