I started my investment career in a trading office, executing trades in the market over the telephone to screaming brokers on the JSE floor. The goal was to trade in line with the managers' desired timeframes and to get a good price.
One of the first things I was told - in a long line of market truisms that were all systematically proved wrong over the ensuing decades - was that the trend is your friend.
In a strongly trending market, you were most often wrong if you betted against the tide, and if you had a contrary view, it was better to wait for the market to stabilise or to show signs of turning before taking your position. If a new trend seemed to have started - for example, a bull run had ended - you were better off latching on to the new trend early and selling, even if the price was not perfect for you. The opposite applied when shares reversed off their lows into a new bull phase. Trend followers surrender to a new direction early on.
Of course, that approach is shunned by many value investors, who claim that if a share offers value, you should not worry about mundane things such as market trends, but buy when stock becomes available. If you have substantial funds to invest, you may also want to pre-empt trends in order to buy or sell enough shares before other market participants catch on to your excellent investment idea.
The problem with market trends is that they take place over long periods of time, often lasting longer than we think they should, and then they change direction unexpectedly just as we grow comfortable with them.
An article at www.greekshares.com puts it well: "The more you get used to being right, the more it's likely to cost you when you're eventually wrong."
Last year was certainly one of unexpected events. While some market participants may have indicated their concern with the low-risk premiums endemic in many asset classes (ranging from corporate bonds and emerging market debt, to the low volatility levels we saw early in 2007, leading to cheaper option pricing), very few, if any, pre-empted the rapid return of volatility and the significant fall-out due to the subprime crisis. And many investors who did anticipate volatility by positioning their portfolios defensively were only right to various degrees for a short period of time before equity markets recovered rapidly, and they were tempted back into the market with the August rally, only to be spat out again as the new year arrived.
I think it would be fair to say that the trend has not been a good friend of late.
Bulls turn tail
A few significant developments have brought the bull trend in the South African equity market to a halt. They can be summed up in three points: a return of risk aversion, slower global growth and higher interest rates locally. As I write this column, the three-and-a-half-year bull trend in South African equities has been broken, but the four-and-a-half-year uptrend is still intact. The 20-year uptrend is also still in place, but very long-term trends can remain intact despite huge price fluctuations, so that titbit is for interest sake only.
Based on market behaviour and indications of volatility levels, the one thing you can be sure of is that the rocky ride is not over. It is highly unlikely that the bull trend will return in the short term - that is, the next six months. A far more likely scenario is a volatile, non-trending market.
So what do you do now?
One upside of a more volatile market is the return of stock selection opportunities. People panic and sell shares low in waves of bearishness, and in the process individual shares can offer great opportunities. A word of caution: trying to isolate the turning point in a downward rally is just like catching a falling knife - you're likely to get hurt.
But if you have a clear idea of where you see value in a share and you have a long-term horizon, by all means let that determine your actions.
As for selling low at this point - this depends on how much time you have, how much of your total portfolio you have in equities and whether or not you have regular cash flow you can phase into the market to take advantage of lower prices as you add to your long-term portfolio. If you have a well-structured portfolio given your circumstances and appetite for risk, and you are contributing to your portfolio monthly, you might be better off sticking with your programme.
Some of the larger shares are between 30 percent and 45 percent off their 2007 peaks. You need to be sure the further declines you expect to avoid by selling at the current levels will be worth the tax liability you will incur, especially if the long-term prospects for the shares remain good. And then you have to manage the process of reinvesting into the shares at a lower price at some point.
Some of the managers of flexible unit trust funds showed their skill in 2007, so if you are investing in unit trusts as opposed to shares, you may be able to find a fund that can take advantage of the shorter-term volatility in the market. Either way, we're in for a different ball game as far as the equity market is concerned, and the last thing you should do is act emotionally.
- Anet Ahern is the chief executive of Sanlam Multi Manager International.