Financial markets continue to be very volatile and challenging for investors. So today I thought it would be worthwhile stopping and reflecting on why we should be considering investing in equities as an asset class and the value that equities can bring to the overall performance of the portfolio.
When we think about equity investing, we don’t think of it in the context of the market environment in the short term. The value that you get out of investing in equities, and what it brings to a portfolio, is longer term capital growth. Associated with that capital growth is the income that can be derived from investing in equities.
Clearly, financial markets and equity markets particularly tend to be more volatile than other types of asset classes. The reason for that is that you’re ultimately investing in companies. Market environments, economic environment, industry structures and all those elements have an important role in how those companies evolve and deliver performance through particular periods.
For example, at the moment we’re clearly seeing a very challenging period for the airline industry, consumer discretionary, retail and energy. All of these sectors are being impacted by what’s occurring on a global footprint. It doesn’t mean that those sectors are always going to be impaired. It doesn’t always mean that those sectors can’t deliver a good solid investment return by the underlying companies that are represented within it. One way to think about this is to extrapolate that in the context of the broader market environment by looking at the performance of equity markets over the longer term.
This chart shows you the calendar year performance of the ASX 200, the domestic Australian equity market and the total return that we’ve seen from 1999. First and foremost, we’ve seen both good and bad performance historically. When we take performance today, look at that in the context that you should expect negative returns when investing in equity markets over a period a time. Probably more importantly, when you look at the average return that we’ve seen over that last 20 year period, it’s just been under 10%. So when people talk about trying to time the market, this is really what we’re referring to in the context of investing in an asset class for growth for the longer term. Not getting caught up in the short term market volatility that often occurs when investors are don’t know what the future might look like. We have seen periods like this before and we have seen financial markets continue to evolve and do better once they’re out of those periods. We believe the current environment is no different.
What causes the instability and volatility we’ve seen in equity markets can vary from period to period. But ultimately, we do believe that what we’re facing into at the moment in terms of the coronavirus, the impact it’s having on economic activity, the impact it’s having on investor confidence and ultimately financial market performance, is cyclical in nature. So this first chart should be looked at when thinking about what you’re trying to achieve when investing in equities, and then start to balance that with what performance has occurred previously. The other important point to note on the chart is that 80% of the last 20 years, so in 16 years, we’ve seen a positive performance out of equities. So even though we’re facing into what is a very challenging first half of 2020, it doesn’t necessitate that what we’re going to see negative returns for the entirety of the year or that this is going to continue over many years to come. Our view is that ultimately, the value that you’ll see in equities will be delivered.
This second chart really highlights that point. It reflects the valuation mix between investing in equities over bonds. We certainly believe bonds have an important role to play in an investment portfolio and the dampening of that overall volatility is really important when trying to balance out the entirety of that investment return through a full cycle. This chart gives you a snapshot on one way that we think about the valuation approach that we take to investing either in equities or fixed income or bonds. When the green line is above that red dotted line equities are expensive and when it’s below it reflects that equities are undervalued relative to bonds. As you can see, as equity markets have continued to deteriorate over the last little while it’s becoming more undervalued relative to the bond market. It’s just one measure that we look at, but there are clearly periods, like 2008 and 2000, where the equity market was overvalued and we saw a correction in that context.
From our perspective, when thinking about the performance of equity markets and as we go through this period, we need to have one eye on the future and one eye around the valuation metric and the opportunities that we believe will be present as we work through the challenges of the coronavirus and the impact that will have on the economy and financial markets in the short term.
The stimulus packages we continue to see from central banks and governments worldwide will provide a very strong backdrop to the recovery, most likely through the second half of this year. But also provide a strong backdrop to financial market performance and part of that will be the performance of equities. So balancing that longer term thought process with a valuation metric and being cognizant of the market environment we’re in, we certainly do believe that equities will continue to play a very important role in client’s portfolios and in delivering and generating wealth for the long term.
As always, if you have any concerns, please reach out to your advisor. If you’d like to continue to receive these updates as we publish them, please click on the link at the bottom of this page to subscribe.
Piers Bolger is Chief Investment Officer at Viridian Advisory
This post and some supporting materials may be regarded as general advice. That is, your personal objectives, needs or financial situations were not taken into account when preparing this information. Accordingly, you should consider the appropriateness of any general advice we may have given you, having regard to your own objectives, financial situation and needs before acting on it. Where the information relates to a particular financial product, you should obtain and consider the relevant product disclosure statement before making any decision to purchase that financial product.
The material in this post is correct and complete as of the data it was posted. Viridian is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained within this site.