The first quarter of 2010, 2011 and well into the second quarter of 2012, it feels like déjà vu all over again!
At the beginning of the last three years equity and credit markets were off to a bustling start. As we approached the second quarter, a combination of macroeconomic, geo-political and corporate news forced the markets to do an about face. The trendless market that resulted left many investors to ponder on their investment strategy.
It was Warren Buffet, one of the greatest investors of our time, who described his ideal holding period as ‘forever’.
But, is this conventional buy and hold strategy that worked so phenomenally well in the late 90s and early 2000s merely a success of the distant past?
Tech boom, bust
The vulnerability inherent in this strategy is perhaps best reflected in the tech boom and bust and recent bear market following the credit crisis. The deep market reversals following these events challenged the validity of this widely held strategy as investors lost trillions of dollars and more than half their wealth. Coupled with changing market dynamics and time horizon limitations, this once seemingly safe strategy appears riddled with risks.
History has proven that the buy and hold strategy does well in a stable and upward trending market. It takes the emotions out of investing, reduces the risk of selling at the wrong time and is less complicated than an actively managed strategy.
Data further suggests that over the longer term, the market goes up on average two thirds of the time and down the other third. Consequently, long term buy and hold investing, when corrections are short lived, can produce excellent gains.
Consider however that analysts expect the remainder of 2012 to have continued volatility much like the prior three years. Markets are expected to experience both breakout rallies and downward corrections.
If you further consider that yield on the 10 year US Treasury is expected to approach 2.5 per cent by year end following the completion of the Federal Reserve’s Operation Twist, the 17 per cent investors earned last year from this security will be replaced by negative returns and a significant dent in their principal adding to the market’s chaos.
Given these expectations, the credit and equity markets should be ripe with opportunities from further volatility as we approach year end.
Adding to the challenging dynamics inherent in this philosophy, the macroeconomic picture is hardly upbeat. The US market is far from the clear following its own debt crisis.
Manufacturing, the saving grace during the crisis, is now seeing a bit of weakness as the New York area and Philly Fed Manufacturing Indices are beginning to trail estimates. Admittedly some of the economic indicators are showing surprising strength with retail sales coming out strong, unemployment improving and corporate earnings remaining robust.
Investors who will survive the volatile markets in 2012 and beyond are those who are nimble and responsive to market forces. The ability to take advantage of wide moves will be key to treading a market that overreacts at any news or becomes paralysed with fear.
Investors will need to take losses if there is no longer a compelling reason to hold a security, if earnings expectations have changed or if the price is outside the target range. Having an exit point before establishing a position and selling into rallies, even at the expense of future gains, are bold skills required for navigating today’s markets.
Bob Doll, the chief investment strategist of Black Rock recently commented that markets have been in a 12 year trading range which started in 2000. Investors with a buy and hold strategy will therefore need to discover additional ways of deriving gains or face negative returns.
Given the dynamics of these volatile markets, the goal for the conventional buy and hold investor should then be; first, to preserve capital during corrections, limit risk by reducing exposures when warranted and to proactively adopt opportunistic trading strategies.
Consistent research of an investment idea and monitoring of the markets to take advantage of down days is paramount to seizing the right entry point. The buy and hold strategy, although successful for several decades, failed miserably in the last 12 years as billions of retirement dollars were lost waiting for markets to recoup losses. In the words of an anonymous philosopher, “it is not how much you earn that is important to me but how much you can keep”, conventional wisdom it appears may very well have its own folly.
Disclaimer: The views expressed are the opinions of the writer and whilst believed reliable may differ from the views of Butterfield Bank (Cayman) Limited. The Bank accepts no liability for errors or actions taken on the basis of this information. Statistics Source: Bloomberg LP