The fat and the thin of it

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Source: Refinitiv Eikon

 

In the book of Genesis the Pharaoh of Egypt was warned by Joseph that he would enjoy seven fat years of good harvests to be followed by seven lean years. Investing’s ups and downs show similarities to the varying floods of the river Nile. In our chart we show (in dark blue) the total return for UK mid-caps over five year periods. Only in the period from early 1998 to early 2003 was the index negative. On three other times it flirted with negative territory only very briefly.

When was the smart time to invest? Here we look to the orange line. This is the same five year total return but this time it’s lagged by five years and inverted on the right hand axis. It tells us what return was enjoyed over the following five years. The person investing in at the low in early 2003 would go on to make a nearly 200% total return.  

And in case you suspect we have chosen a particularly favourable period for our chart, here is a similar one covering all UK stocks from 1970 to 1990.  With this chart we also deflated share prices to reflect the change in the retail prices index. (This understates the true five year returns by about 4% but, hey, that’s statistics.) Notice that at every point where the five year return was negative, even on this harsh RPI basis, it made sense to be buying rather than selling. The time to increase investments is after the  bad times.  

 

Source: Refinitiv Eikon

 

The lesson is simple but of course a hard one to follow in practice: the best time to buy is when everything looks the most grim. Many people buy near the top and sell near the bottom. This just magnifies the returns for more level-headed investors with a medium-term perspective.

 But why don’t the bad times just get even worse? It’s because capital continues to quietly compound its returns each year. The capital in a business at year end is more than at the start of the year and, like a decent deposit account, it generally makes a bit more return each year from that larger capital. This is isn’t just arithmetic. Knowledge also accumulates and the world gets smarter. Robot vacuum cleaners, robot taxis, robot warehouses: in investment terms they mean more money for people to spend – and invest – on better things.

 

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