Why are we convinced ‘this time it’s different’?
We’re at the stage of the investment cycle where, in times past, many investment advisers would be quoting with enthusiasm a comment John Templeton had made many years ago:
“The investor who says ‘this time is different’ … has uttered among the four most costly words in the annals of investing.”
Templeton was alerting investors to the dangers of the recurring view in markets that, because the big influences on investments are seen to have changed fundamentally, the future for investors will be very different from the past.
Some things are different, some are familiar
For young investors, I should point out John Templeton was an outstanding investor and fund manager—and a generous philanthropist—who did much in the 1950s to set up and popularise managed funds. In 1999, Money magazine called him “arguably the greatest stock picker” of the twentieth century.
And like Warren Buffett, John Templeton had studied at Yale under Benjamin Graham, the great teacher of value investing. His 16 rules for investment success, first outlined in 1933, also included his famous aphorism:
“Bull markets are born of pessimism, grow on scepticism, mature on optimism and die on euphoria.”
These days, many investors believe that COVID-19 has profoundly and permanently changed how investment markets work. In my view, this prevailing sentiment is over-stated: some things will be 'different' while others will stay familiar.
COVID-19 is the worst pandemic in a century and the first to occur in our now highly globalised world. The initial panic was heightened when some major health institutes projected multiple millions of deaths, and the future course of the pandemic is highly uncertain.
By early March, COVID-19 was already bringing about the quickest and deepest economic downturn in history, and one which would worsen as lockdowns and social distancing requirements were introduced. Around the world, governments and central banks announced an unprecedented easing in fiscal and monetary policies.
In five weeks from 20 February, average share prices plunged more than a third from record highs. Between 23 March and mid-June, much of the heavy drop in share market indexes was recovered, mainly at times when rates of new infections from COVID-19 in the US and Europe were falling. Share markets have been volatile and unusually uneven by sectors and across individual stocks.
As well, the pandemic has worsened the already tense relations between the US and China, and contributed indirectly to social unrest and riots, notably in the US.
John Templeton frequently reminded investors that share markets have a long history of over-reacting, both in the tough times and when investors turn optimistic. And Howard Marks, deservedly now one of the most-quoted by Australian investors, recently reminded us:
“… the most optimistic psychology is always applied when things are thought to be going well, compounding and exaggerating the positives, and the most depressed psychology is applied when things are going poorly, compounding the negatives. This guarantees that extreme highs and lows will always be the eventual result in cycles not the exception.”
Three reasons it's not just the Fed
As well, the long-familiar view 'Don’t fight the Fed' has had another airing. Certainly, the switch to a more positive sentiment in stock markets in late March owed a lot to the Fed’s aggressive programme of buying bonds. The further uptick in stock markets during June was attributed to the Fed’s direct purchases of a wider range of corporate debt including low-rated borrowings.
But investors seem to be exaggerating the role of the Fed. This time around, relatively little attention has been paid to at least three other influences that affect share prices.
One is the massive fiscal boosts most countries have implemented, which will likely be extended on only a slightly reduced scale into 2021.
Two is that the early indications that the hit on global GDP from COVID-19 will be milder than expected earlier provided there’s not a second wave of infections in Europe and the US. High-frequency data suggest both the US and Australian economies have passed the low points of their slowdowns. Retail sales in May rose by 18% in the US and by 16% here.
Three, it appears to this elderly scribe that there is another familiar reprise. It’s that this time any recovery in overall economic conditions won’t be V-shaped but instead will be more configured like an L or a W. Similar comments were made during economic slumps in 2009, 2003, the second half of the 1990s, 1983, the 1970s and even in Australia’s recession of 1961 (which at the time was said to mark the end of our post-war prosperity).
What to watch
Market sentiment will likely continue swinging widely in coming months. Gloom will re-appear whenever, for example:
· the pandemic gathers momentum
· well-liked companies report unexpectedly weak earnings
· a cluster of reports is released with disappointing economic figures.
But share prices could well resume their bumpy recovery as investors recognise the global economic slump is somewhat milder than was feared and expected, particularly if the fiscal boosts are tapered rather than suddenly removed. Of course, share markets could move up noticeably if a vaccine is discovered.
Investors should reflect on John Templeton's advice when the prevailing market view is 'this time it’s different' and also bear in mind another of his investment principles:
“Don’t panic. The time to sell is before the crash, not after.”
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