Why we use past performance and time the market
Just do it intelligently
TWO OLD PIECES of investment advice are referred to so often they have virtually become market lore. Roughly, they are: “Past performance is no indication of future performance” and “You can’t, and shouldn’t, try to time markets”.
At a basic level both are extremely good advice, particularly when aimed at investors fired up by greed or making irrational decisions through fear. But as any experienced investor will know, both past performance and market timing are part of just about any investment decision – even if the investor isn’t fully aware of it.
Past performance is often all we have to go on. Analysing a company’s financial statements is fine, but when you want to form a view on how it will perform in the future under certain conditions, what do you do? Look at how it performed under similar conditions in the past. It’s not foolproof but is often the most reliable indicator we have.
The same with a unit trust fund. Investors know not to chase the top performer over a short period. But if you look at longer-term performance tables, the funds that consistently come through in the top quartile are likely to be the ones that will continue to do so. Also not foolproof but often the most useful information we have.
Then there’s market timing. We all do it – not silly attempts at trying to call the absolute bottom or the top of the market but making educated guesses about where a share is in its particular cycle.
Take resources shares. Investors have to make a decision on where the market is – market timing, in other words. You aren’t going to buy gold mines when the gold price has recently hit record highs and is now falling sharply. But when the gold price has been low for a long time and there are indications it’s going to improve, you’ll probably then buy the mines. Market timing.
The advice on past performance and market timing remains good. But at times investors will bend it. It’s best to be aware that will happen and try to keep investment decisions as informed and unemotional as possible.
With that in mind I was interested to read the views of Peter Eerdmans on emerging markets and his conclusion they could be close to the “bottom”. Eerdmans is head of emerging market debt at Investec Asset Management. How did he reach that conclusion? By drawing parallels with history – past performance.
Eerdmans makes some important points. Markets bottom by, say, six to 12 months before the real economy does. And they will start to price in recovery long before the economy starts picking up. Though not always super efficient, markets are therefore good forecasters of the economy. And that invites intelligent market timing.
But it’s past performance that Eerdmans is using. He looks at the Asian crisis in 1997 and the Russian default crisis in 1998. During the Asian crisis the key JPMorgan emerging market currency index lost 18% over the second half of 1997. In the crisis we’re currently in it has lost 19% over the past three and a half months.
In the Russian crisis, JPMorgan’s emerging market dollar bond index lost 32% over a six-month period. Eerdmans notes the bulk of the sell-off was in the last month of that period. Currently, the index has lost 30% – with the bulk of the move in October.
“The above numbers suggest we could be very close to the bottom. The moves are of similar magnitude and similar size,” he says. But Eerdmans cautions “things are never exactly the same”. Two important differences are that the G7 developed countries are heading for, or are in, recession, whereas they were in better shape during the 1997 and 1998 crises.
But then again, he notes emerging markets are much stronger now than 10 years ago, with foreign exchange reserves, current accounts and reliance on external flows scoring better on average.
His advice is not to be too bearish now, remembering that markets don’t wait for the bottom in economic activity but start pricing in the upturn before it actually happens.
SHAUN HARRIS firstname.lastname@example.org Markets bottom before economy does. Peter Eerdmans