Is now a good time to be invested in the stock market?

There is a lot of uncertainty in the wake of the General Election. Which policies will come to fruition? How will the UK leave the EU? And what could all this mean for the stock markets? Coupled with the fact that the FTSE 100 and S&P 500 are currently near or at all-time highs, the question on many people’s lips is – is now a good time to be invested in the stock market?

 The short answer

We believe that investing should be for the long term, and that markets and the economy have a tendency to rise over time. For investors, this should mean a return on investment for people who can ride out the ups and downs along the way – a reward for the extra risk they’re taking.

A key aspect of our investment philosophy is to let time do the heavy lifting for us – basing our investment decisions on the fundamentals rather than trying to time the markets or second-guess rises and falls in prices.

We often see headlines referring to new record highs for the FTSE 100, S&P 500 and other stock markets. While index values are a useful indication of the health of the stock market, it is worth remembering that these figures are based solely on share prices.

Importantly these prices don’t give the whole picture. We also need to look at valuations to get a clear sense of the state of the market. And while prices may be at all-time highs, we don’t believe that valuations are necessarily stretched at the moment.

To highlight this distinction between prices and valuations, let’s consider average wages alongside the price of bread. According to the Office for National Statistics, in 2000 the average worker was earning ￡15,600 and a loaf of white bread cost 51p. In 2017 these figures have risen to ￡26,156 and ￡1.02 respectively*. And yet, in real terms we are not earning significantly more and bread is not significantly more expensive.

This is why we shouldn’t focus solely on prices – we also need to consider the underlying value of the companies.

Regardless of whether we look at prices or valuations, some people are reluctant to invest at the moment because they believe the markets are poised for a downturn. And yet, throughout history we have seen rallies and selloffs time and time again for a variety of reasons.

With long-term investing we can expect cycles – periods of falling prices followed by a recovery. A key to successful investing is being comfortable knowing that there will be falls as well as rises in the market.

Many people will remember the dotcom bubble of 2001 and the global financial crisis of 2007. The effects of these events on the UK stock market are shown in the graph below, which compares the returns from holding cash with investing in UK equities and reinvesting income over the last 30 years:

UK stock market and cash returns

Source: Lipper for Investment Management, at 31 May 2017

Both crashes caused big losses for investors – these are represented by the two dips in the red line. However, as the line rises we see recovery and a return to profitability for those who stayed invested for the long-term. The numbers show that it took six years for the stock market to recover after the dotcom crash, and four years and four months after the global financial crisis.

Although stock markets are cyclical in nature, markets and wider economies have a tendency to rise over time. This applies to everything from share prices and earnings to wages and the price of household goods.

The graph shows that stock market returns stayed above that of cash even with the sell-offs of 2001 and 2007 (although we must remember that past performance isn’t a reliable indicator of future performance).

Investing is for the long term

At Tilney we believe that investing requires patience and taking a long-term view. When we make investment decisions we ignore ‘market noise’. Instead, we focus on the fundamentals and changes in value – these are the key drivers of long-term returns and they are possible to forecast with a degree of accuracy.

On the other hand, short-term returns are driven by changes in valuation and investor sentiment. These are impossible to forecast consistently, and trying to time the markets can also mean potentially locking in losses and missing out on gains.

This is why we do not try to time the markets or make short-term trades. While we may sometimes make marginal tactical calls if opportunities or risks present themselves, we always maintain longer-term strategic asset models.

The effects of compounding

Compounding is one of the reasons long-term investing has the potential to give such great returns. This is the snowballing effect of your returns generating more returns. Albert Einstein reportedly called it “the eighth wonder of the world.”

In the stock markets, compounding is usually a result of reinvesting dividend income. Companies are collectively owned by their shareholders, and their board members may agree to pay investors their share of the profits through a dividend.

Dividend-paying shares are a staple of most income-seeking investors’ portfolios, but when the income is reinvested we can see a significant increase in total return over time. This makes them ideal for investors who are seeking growth – especially as a stable and growing dividend is seen as a sign of good corporate governance.

To see the effects of dividends, this graph compares the total returns from the UK stock market over 30 years, both with and without reinvested income. If you had invested ￡1,000 in 1986 and reinvested all of your dividend payments back into the stock market, your total return would be ￡14,250. If you had taken out a regular income your total return would be ￡4,150 – more than ￡10,000 less.

The risk of keeping your money in cash

When people feel nervous about investing – perhaps due to political uncertainty or the markets being high – a common reaction is to sell their investments and keep their money in cash. Cash is seen as a ‘safe’ asset, but it does leave investors open to the risk of inflation.

Inflation is known as the silent killer, and it erodes the buying power of your savings over time. Your account balance doesn’t change, but you can buy less with your money. Inflation (measured by the Retail Prices Index) is currently sitting at 3.5%, and forecasts are for this inflationary environment to continue for the foreseeable future due to sterling weakness in the wake of the Brexit referendum.

This graph shows the effects of inflation over the last 30 years. If you had ￡1 in 1987 and left it untouched you would still have ￡1 today. However, taking into account increasing prices over the last 30 years, your ￡1 would only actually give you 38p of spending power in today’s money:

In conclusion

Although markets are at high points and there remains uncertainty over the political future of the UK, we see no reason not to be invested in the stock market in the current economic climate. We are confident that good returns can be found for investors who are comfortable taking a long-term view and riding out any market volatility.

At any moment in time there will always be reasons not to invest and scenarios to worry about. However, we must remember that every period of time spent out of the stock markets is a period of time potentially missing out on returns. As we have seen, these periods of good performance tend to provide a positive overall return over the long term, even with falls in the market along the way.

So if you have a long time horizon and can accept the fact that markets tend to rise and fall along the way, we believe that now is as good a time as any for you to be invested in the stock market.

See you soon.... Zahir