Recognising the cost of fear

Can you remember what you were doing around this time four years ago? If you are an investor with a stake in the international stock markets, then four years ago you were in the depths of despair. The S&P 500 was posting crushing lows in the region of 670. There was panic about banks going out of business and further market turmoil.

Enter the US Federal Reserve, its Troubled Asset Relief Programme (TARP), quantitative easing programme, and its stress testing of banks to provide some comfort to the markets and four years ago also proved to be the beginning of one of the best bull market runs of all time.

As at Friday, last the S&P 500 closed at 1551, which represents a cool 129 per cent, return on the S&P 500 index in around four years. I am sure every investor would take that type of return if, however, they were able to get it. You can’t get it if you are not invested and most people would have been out of the market running scared in March 2009.

So let’s look back a bit at the advice that was offered in this space during those times of turmoil when local investors were running scared, not just from the failures of US banks such as Bear Sterns and Lehman Brothers, but also the collapse of CL Financial. 

The right time

The rationale for looking back is not to brag but to make a point to those who sit idle watching the market waiting for the “right” moment to step in. It is aimed towards people who react to the fear in the market and prefer to sit in so-called “guaranteed” investment products which either pays a rate of return that will not allow you to achieve your financial goals, or that you pay such a hefty price for that guarantee, that it may be more sensible to prudently manage the risks of the market. The latter speaks to the number of structured products on the market that provides a guarantee. The cost of structuring often takes away much of the upside.

March 26, 2009, I opened with the following quote from motivational speaker Gary Blair: “You cannot afford to wait for perfect conditions. Goal setting is often a matter of balancing timing against available resources. Opportunities are easily lost while waiting for perfect conditions.”

For many it is a case of so said so done. We all have financial objectives, but very few actually set those as goals so that it can be achieved. We operate on a whim and so with markets falling, the simple yet faulty logic was to wait for the perfect opportunity to get back into the market. Sadly, it never came and this is true for international investors as well as those positioned in the T&T stock market. 

The end result was a huge number of persons who lost out on four years of building their retirement nest egg. If you were aged 40 in March 2009, it meant that you had 240 months to go to retirement. Today, that number is down to 192. 

If you spent four years (48 months) locked in at progressively lower-fixed income rates primarily out of fear, then it means you now have 192 months left to generate above average market returns in order to achieve your retirement goals or be left with less to retire on. Given that the markets were during those four years actually providing above average returns, it is a huge opportunity lost. 

Smart money

The cost of avoiding risk today is a heavy price to pay down the road. The lack of risk taking translates into a lack of return and the lack of return means that you either have to save more money to achieve your goals or reduce your expectations of how much you will have to spend down the road. Your fear of wanting to preserve a particular lifestyle by seeking safety means that you run the risk of losing out on that same lifestyle in the future because you were afraid.

On November 20, 2008, while the market was still in what seemed to be a bottomless turmoil, I offered the following bit of advice: “At the end of the day, the key lies not in correctly anticipating the exact bottom of the market, but rather to anticipate the stocks and sectors that will outperform and this is where the smart money will go. Get this right and you will have nothing to fear.”

Appreciate, if only in retrospect, that a stock market’s job is to “climb a wall of worry”. Yes, there was a lot to worry about then, and even now there is quite a lot to cause concern and those concerns are often highlighted here. The truth is there will always be some issue that one can point to that can cause the market to go down.

The reality is that as an investor, you are not in control of those issues. The only things you can control is how much you invest, how often, the degree of risk you are prepared to take and who you choose as your financial adviser. 

Everything else is simply noise.

Taking advice

So what about your choice of financial adviser? During this crisis period, many overseas advisers operating in T&T, along with quite a few local counterparts, were suggesting publicly that in the falling market, the place to invest was in defensive stocks, with the call being to go into consumer staples and health care stocks. 

My call on October 16, 2008, was just the opposite suggesting resources, materials and commodities as the place to be. Quoting the article written back then: “The general consensus is demand destruction will cause a drop in commodities, hence the sell off. I have seen projections for oil down to US$30. I disagree, there is likely to be a continuing sell off over the short term, but this is where the opportunity lies. Everyone else is talking about health care and consumer staples as the sectors to look to for upside from here, but I submit a consumer-driven recovery will not be sustainable.”

The performance of commodities such as oil, gold, silver, copper and others over the past few years is a matter of record. That trade has, of course, now run its course and the upside from here is limited, especially given the strengthening US dollar. However, there always tends to be a rotation moving from one sector to another. The important thing is not to get carried away with the hype and hype is often the case when someone wants to sell you something.

To appreciate the point just look at Apple. Rising to US$700 per share in September/October last year there were many predictions of Apple reaching $1,000 during the course of this year. Today the stock is climbing off a low of US$419. Such a precipitous drop for a company with a price to earnings (P/E) ratio of under ten times a dividend yield of 2.5 per cent and US$150 per share in cash. 

There will be many an investor who will be afraid of getting into Apple because the stock has fallen 40 per cent in less than six months. Yet these same investors will happily look to the “safety” of a ten-year bond with a yield of 2.5 per cent, even though such a yield implies a P/E multiple of 40 times. 

Both the Apple stock and the hypothetical bond carry similar cash flows at this time in the form of the dividend and interest yield, respectively, yet the bond is significantly more expensive than the Apple stock as measured by the price to earnings. Therein lies the irrational tradeoff between risk and return that haunts many an investor.

These irrational actions are often the product of fear. It should be clear that being fearful has a cost. Many investors will not see that cost today because in running to the “fear trade” they get the illusion of safety. The cost of fear is seen decades later when it is time to retire and you realise that there are insufficient funds to live the lifestyle that you dreamed off at retirement.

Ian Narine is a broker registered with the Securities and Exchange Commission.

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