It will only end in tears…

It will only end in tears…

Predicting stock market corrections is a little like playing the lotto – if you do it often enough you are bound to get it right eventually. Problem is that by then you would have spent so much time trying that no one would be listening anymore. So I am not predicting any correction but I am predicting that the kinds of returns that we have seen from the SA equity market are not sustainable and that at some stage we are going to have to give back – whether that is in the form of a correction or a sustained period of under-performance, no one knows. But give back we will!

It was Warren Buffett who said “Be fearful when others are greedy and greedy when others are fearful”. When people start to get greedy then it is time to be fearful – from what I am seeing around me, it is time to be getting fearful.

For example, we had a client inform us that he was moving his living annuity investment to another firm who were offering him the opportunity to invest his annuity funds in a direct equity share portfolio. Living annuities are not, as a rule, the place for a direct equity portfolio. Yet like a pig at the trough, he is no longer content with the consistent inflation plus returns that he has been receiving. He still wants more and is going to sell his well-diversified funds to buy direct SA equity at these record levels. It will only end in tears.

Similarly the number of enquiries from people who suddenly want to invest cash has increased substantially. They all either have friends who have made a fortune from the market or have been to investment presentations where presenters have proudly displayed recent past performance. Who wouldn’t want a share of that? Be warned, however, fear and greed are the 2 primary emotional drivers of the market…and right now there is plenty of greed and not enough fear around.

We know, from long periods of history, that equity markets can be expected to deliver real returns (after inflation) of around 7-9% per annum (with a significant amount of volatility in any given year). The past 10 years in SA have seen real returns well in excess of this with lower than normal volatility levels and the past 2-3 years has seen real returns of close to 20% from the equity market (volatility has been about half of the norm).

Similarly, returns from balanced funds should be in the range of 5% real – many funds have given almost double this for the past for the past 5 years. We should not expect these returns to continue.

Research published this week by Cannon Asset Management showed that if SA Large-cap industrial shares were a market on their own, they would be the most expensive market in the world. The problem is that long term investors can’t afford not to be in the market but they would do well to remember the following:

  • Markets move in cycles: they go up and down over time (not necessarily in that order).
  • Nobody knows exactly when this will happen – no one can consistently time the markets.
  • Equity markets should provide out-performance over the longer term (>10 years) but they are also more volatile over shorter periods.
  • High risk does not necessarily imply a high return (take gambling for instance).
  • Diversification is the prudent way to manage risk. This includes diversification among various asset classes, regions and investment styles.


Added to this, investors also need to understand the various risks that they face.

  • Short term risk – Volatility

Market volatility is not a new thing and could impact on investors who need to access their capital in the short term, forcing them to realise (potential) short term losses. In our view “short term” represents your income need for the next two/three years. The strategy to manage this specific risk is to invest this portion of your capital in cash instruments such as the money market. Your liquidity needs should define your cash portfolio and this is the reason for keeping money in the money market or enhanced income type funds.

  • Long term risk – Inflation

Over the longer term your greatest concern is whether the real value (purchasing strength) of your income and capital will keep pace with inflation. If inflation is currently at 6% per annum, then a current income need of R20000 per month will equate to ±R36400 per month in 10 year’s time.  It is therefore essential that the growth on your investment portfolio outstrips inflation (after tax) or your financial position will deteriorate over time. History has shown us that the best investment strategy to manage inflation risk is to make use of the equity markets. (Money market funds and interest earned on a bank deposits have historically not beaten inflation after tax.)

  • Market timing

Many investors (and advisors) fancy themselves as gurus with the ability to pick the right sectors and to time the markets. The research seems to indicate that exactly the opposite is true. Research showed that the “Average diversified fund returned 8.2% p.a. over a 20 year period (1992-2011) but the average investor only achieved 3.5% over the same period” (study by Dalbar Inc, Mar 2012).

The most obvious cause of the above findings is the “classic” investor error of buying high and selling low (greed and fear). Investors choose today’s number one ranked fund and after a while when its star has waned and the ranking has slipped they impatiently (and often irrationally) sell out of it and get into the next top ranked fund. Good fund managers do not become bad fund managers over night! Alternatively, buy an index tracker and forget about it – you will get a consistently better than average return at lower than average fees and as a result will end up on top of the pile!

Others think that they will get out of the market and stay in cash (at least until the volatility is over). It is, after all, safer and maybe they will get back into the markets at a later stage. What investors (and advisors) don’t realize is that:

  1. You can’t consistently pick the winners (you’d be better off buying the losers),
  2. You can’t repeatedly time the markets (no matter how good you think you are) and
  3. If you want to accept cash returns as your worst case scenario, then you also have to accept cash returns as your best case scenario.


Finally, investing is about probability and not prophecy. We don’t know which sector will perform best next nor do we know when the rand will weaken further or even if the market has hit its top. We do know, however, on balance of probability (built up over a very long time) that as an asset class, equities should outperform property which should in turn outperform bonds which should outperform cash (after tax). This is a fundamental consequence of the risk/return relationship. In fact, statistics show that SA asset classes have produced the following real returns over time:

Asset class

Real return









Source: Fortune Strategy, Bradley et al (the international experience is similar)

If I had cash to invest right now, I would phase it into the market/funds over a period of months – you don’t want to invest at the peak but you also cant afford to be out of the market. If you already have funds invested then take a good look at them and rebalance your asset allocation if necessary.