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Rainy Day Investing

By Jim Parker – Guest Contributor

rainy day copyAustralia, earth’s driest continent, experienced national rainfall in 2017 that was 8 per cent above the historical average. The year was the 30th wettest on record, according to the Bureau of Meteorology.1 But the story is more complicated than that.

While rainfall on a national basis was much higher than normal, the downfalls were concentrated in the west of the country. In much of eastern Australia, including many normally fertile farmland areas, rains last year were well below average.

Like farmers planning a harvest, investors pinning their expectations on statements about arithmetical ‘average’ returns can be disappointed. As with rainfall, market returns are rarely evenly distributed either across time or place.

Of course, one could take one’s cues from the financial news, which tellingly is normally scheduled just before the weather forecast on the nightly TV news bulletin. But there isn’t much evidence of anyone being able to consistently and reliably forecast market returns one year to the next, never mind one day to the next.

For instance, going all the way back to 1926, the US share market index, the S&P 500, has had an annualised compound return of 10.2 per cent in US dollar terms. Yet, on only six occasions in the intervening nine decades has the individual calendar year return been within two percentage points of that result. As a single number, an average result ignores the distribution of possible outcomes. For  example, the S&P 500 has been up or down by more than 20 per cent in a calendar year on 40 occasions in this nine- decade period.

In Australia, from 1980 until the end of 2017, the benchmark S&P/ASX 300 index has had an annualised return of 11.3per cent in Australian dollar terms. Yet only in five years of that near four-decade period have individual calendar year returns been within two percentage points of that average. Individual year performances range from as low as -38.9per cent during the year of the GFC in 2008 to +66.8% in 1983!

Just as precipitation varies across place, so too do market returns. For example, developed equity markets in 2015, as measured by the MSCI World index, returned 11.5per cent in AUD terms in 2015. But at an individual country level, returns extended from as high as +38.8pr cent for Denmark to as low as -14.7per cent for Canada.

Guess what happened in 2016? Canada vaulted from worst to best performing market, with a return of 25.2per cent. But Denmark slid all the way from top to bottom, with a return of -15.4per cent. Overall, developed markets gained just over 8per cent in 2016.

It’s hard to pick, isn’t it? Perhaps there’s a lesson from farmers here. Faced with climate variability and unpredictable patterns in precipitation, some farmers diversify from single crop agricultural systems to several different crops, or they rotate from crops to grazing livestock. Others build completely new businesses on their land, such as poultry farming, tourism or renewable energy.

Likewise, for investors, an expectation of ‘average’ returns every year is likely to lead to disappointment. But if they accept that they do not know when or where the ‘rains’ will fall, they can focus instead on building structured, diversified strategies.

This way, they are more likely to capture the returns wherever they happen to occur in markets around the world.

If you enjoyed this article, we have plenty more to read here, or visit our SmartInvestor.TV page to watch a range of educational videos.  For award winning financial advice, contact Capital Partners on 6163 6100.

1 ‘A Year of Contrasts for Rainfall’, Annual Climate Statement 2017, Bureau of Meteorology, Australia.

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