About a week ago, at a social event I faced a rhetoric question of where do I see the equity market in the new year. Am I still in the camp of stable market for the next few quarters and a rally at the fag end of year 2022?

I answered nonchalantly that price-to-earnings (P/E) ratios are at very attractive levels and growth target of the economy looks intact, but we need to be wary of the current account deficit (CAD) and our relationship with the multilateral agencies.

To this, my friend responded, “so you are aligned to the market as we are hearing the same from everyone”, and we moved on to other discussions and enjoy the festivities.

The response of my friend made me have a sleepless night. The fact we are hearing the same from everyone else immediately switched my “paranoia radar” on and nudged me to try to figure out what we are missing.

Conventional wisdom suggests that we cannot outperform a benchmark and generate ‘Alpha’ in the market by following the popular view.

If one’s objective is to generate decent returns over long term with minimal effort, then the best way to capture ‘Beta’ is to follow the market view and stick in there.

During my early years of wealth management career, I was introduced to an investor who always had his timings right as his entry and exit levels were perfect matching the troughs and peaks of the market and making his return mythical.

His problem was that he only predicted the outcomes after they have occurred. He was aptly and fondly referred to as ‘Harry Hindsight’.

The problem with the real world is that investment decisions are made prior to the outcome and it means we need to factor in uncertainty, which creates the need to plan before we can act.

Changing dynamics

Global pandemic has changed the dynamics of business. What flourished previously is now difficult to sell while those products that were difficult to sell are now selling like hot cakes.

With Omicron hitting the globe with full force and ‘Deltacron’ planning to bring a new twist to the party, we can expect a fresh wave of lockdowns in the economy.

Looking at a 50-year horizon, globally over any 12-month period, equities have historically, on average, outperformed bonds 60-70% of the time. Therefore, it makes sense that the consensus is for equities to outperform in the coming 12 months as this is the most likely outcome.

We could be going through a period of multiple 12 months, where maybe exceptions to this historic data.

There could be two possible pitfalls by following this investment case. An investor may end up investing in a small basket of assets increasing the volatility of return and riskiness of the portfolio.

As the pain of loss is higher than the emotional benefit one gets from financial gain, an investor may choose to keep funds on the sidelines and invest in lower-yielding fixed-income securities, thus giving up potential gains and also losing purchasing power over time due to inflation.

For a well-thought-out long-term investment strategy, the investor should start with determining their investment allocations, keeping a two to three-year horizon in mind.

Once the course has been set, drip feed savings to convert them into investments by starting small and consistently. On market correction, block investments can be made to capture better buying levels.

It is key to listen to doomsayers but with a pinch of salt such that the attractiveness of the levels doesn’t slip off the radar.

Key in this is to ensure that we have a diversified portfolio and allocation to niche areas is avoided in the first phase. Once a decent diversified (35-40%) portfolio has been established, 10-15% allocation can be made to these wish list investments.

Diversification gives a peace of mind because in case of a negative price movement, the downturn in portfolio value would be much smaller than it would be in case of a concentrated portfolio.

Effectively, admit to yourself and your loved ones that, unfortunately, your name is not Harry Hindsight.

The writer is a student of Behavioural Finance, a treasury and wealth management professional and a visiting faculty at IBA

 

Published in The Express Tribune, January 31st, 2022.

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