A guide to investing in uncertain times

After two strong years following the major Covid-19 correction in March 2020, the stock market is going through some large gyrations. More than ever, investors need to recalibrate their expectations and pick stocks wisely.

The stock market is starting to position itself for interest rate rises by central banks. Companies that are seen as victims of rising commodity prices and supply constraints are being punished. The likes of Kogan are being hit hard because they don’t keep inventory, while Harvey Norman and JB Hi-Fi are being rewarded because they do not have such supply problems. Shortages of cement, timber and steel are hitting the building industry hard. Probuild has gone under. 

What should investors be thinking in this brave new world? Here are 10 keys to investing in uncertain times:

Don’t bank on repeating past investment performances; keep expectations realistic

It is important to realise that past returns are not guaranteed. The world has changed a lot in the past few months: the war in Ukraine; supply chain problems; rising inflation and fears of interest rate rises. All these have the effect of spooking the stock market. Investors need to realise that past returns are unlikely in the foreseeable future.

Understand what the bond market, and other economic factors, are telling you

The bond market is the world’s biggest investment market and is a great indicator of economic health. It takes into account expectations for growth, inflation and interest rates, so investors ignore it at their peril. Recent changes to US two-year to 10-year bond yields suggest bond investors are seeing some early signs of inflationary pressure. Both US and Australian bond markets are expecting weak growth and inflation. (When the two-year yield goes above the ten-year yield, which is known as ‘inverting’, a recession is more likely). Another key factor here is the US budget deficit. The US debt load is currently more than 100 per cent of GDP.

Similarly, economic news is worth noting. Every week economic indicators in major economies have the potential to move markets and must be watched and analysed carefully. The bond market looks at expectations for growth and inflation. Other data in key economies like the US and China are crucial, including employment data, retail sales, wages growth and industrial production. The numbers must be measured against trends and expectations, both of which have been built into asset prices.

Understand that investing is for the long term

Investing is not for the faint-hearted, nor for those looking to make a quick buck. Investors’ horizons should be in years, not months. It is important that investors learn to ride the downs, as well as the ups.

Don’t borrow money to put into non-investment or non-income generating projects

Borrowing money to invest should always be done carefully, and with full knowledge of the consequences if the market falls. Borrowing money to buy non-investment assets or non-income generating projects, such as cars or beach houses, should be undertaken with extreme caution. Repayments must be able to be made, on time, from other earnings.

Listen to market ‘noise’ and assess its relevance

There will always be ’noise’ in the market, including chat and rumors, mostly unsubstantiated, on investment blogs and websites. More often than not people who contribute to such forums are simply talking up their own portfolios, which probably include junior miners and penny-dreadful stocks, hoping others will invest and prop up the share prices, or even allow them to exit their holdings. By all means, listen to this ‘noise’, but be very careful about acting on it.

Do your due diligence before investing

There are many sectors to invest in, but which ones have the best long-term future? Technology? Healthcare? Finance? Once you have picked your sector, the key things to look at when considering an investment in a company are revenues, profits, dividends and stewardship/management. What footprint does the company have in its sector? What is your first-cut exit price and stop-loss price? What are your expectations for your investment? Can a stock you are looking at really give you a 20 per cent annual return? Be pragmatic and realistic.

Know when to cut losses, reduce exposure and when to hold onto a good stock

Over the years millions of investors have lost money because a stock they had high hopes for headed south and they refused to sell, thinking that its fortunes would turn around. But when a share price hits zero and the company goes into liquidation investors lose the value of their investment. Good investors know when a stock is not living up to expectations and sell, accepting the resulting loss. The Australian stock market is littered with the corpses of companies that went belly-up after promising much: including Bond Group and Bell Group, Allco Finance, Babcock and Brown and, more recently, Quintis.

Equally, there are many examples of companies that have done extraordinarily well over a long period and investors who held onto the shares, and resisted selling on the way up, benefitted hugely. In many cases, shareholders who did their due diligence and were happy to remain long-term shareholders might have increased their investment by more than 1,000 per cent. The Australian example that springs to mind is CSL, which was listed on the ASX in 1994 at $2.30 a share. The company’s shares are now more than $270. The company had a 3-for-1 share split in October 2007, so in fact, CSL shares are today the equivalent of more than $800 each. That’s a return of more than 350 times the initial investment, not including dividends.

Don’t ignore foreign assets, think globally

Australia represents 1.5 per cent of world stock markets, so any balanced portfolio should include some level of exposure to overseas stocks, either individual stocks or via international funds. Successful Australian investors think and look globally. Not only does exposure to overseas markets enable investors to benefit from market movements there, but it gives exposure to sectors that are small in Australia. For instance, the technology sector in Australia is tiny, but in the US and elsewhere there are the likes of Apple, Google/Alphabet, PayPal, eBay, Nvidia, Tencent and Alibaba Group. Similarly, the international healthcare and pharmaceutical sector includes giants like Roche, GlaxoSmithKline, Express Scripts and Novo Nordisk. Global finance companies that Australian investors can only buy on overseas markets include Goldman Sachs and JP Morgan.

Manage risk – money, market, timing and political 

Successful investors manage both money and risk. They keep track of money that is going out and maintain a cash balance to meet all expenses. Risk management is equally important. What happens if markets turn south? What happens if your companies reduce their dividends by 10 per cent? What about 50 per cent? Highly-geared investors with long positions during the Twin Towers tragedy in 2001 or the 2008 market meltdown, when markets dropped by 60 per cent, lost a lot of money. The Covid-19 situation was equally challenging with many companies reducing dividends and some not paying at all. Political risk is also an issue. What are the chances of a change in government at an upcoming election, and what might that do to stock markets?

Don’t get caught up in investment fads

Whether tulips in Holland in the seventeenth century or railways in the US in the 1840s, investment booms always eventually create havoc and never meet investors’ expectations. Fear of missing out is a big driver for many investors, but the reality is that the vast majority of fads end in tears. Bitcoin is one of today’s fads. Bitcoin hit A$90,000 late last year and today is closer to A$55,000. Needless to say Bitcoin, and similar fads, are extremely volatile and anyone who has them as a major asset is taking an enormous risk.

Rodney Horin is CEO of wealth manager and aged-care provider Joseph Palmer & Sons

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.