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I have this theory about betting on test match cricket, and it’s roughly the same as my investment strategy.
It goes like this.
Across five days, almost every game I have ever seen has swung in favour of one team, to the other, and back again.
Maybe one team starts well, then falters, but comes back strongly on the third day.
As a result, looking at betting odds through the game, it’s often possible to bet on both teams at favourable prices.
If England start the first day well against India, it’s expensive to bet on England winning – maybe 3/5 (a 60% profit if correct). But you can bet on India at 5/4 (125% profit).
But then India fight back late in the day and start well the next morning. Suddenly, it’s possible to bet on England at 7/4 (175%).
But the only constant in cricket, just like markets, is surprise, and cyclicality.
Trees don’t grow to the sky, markets don’t go up forever, and in cricket, one wicket often brings another. Change comes quickly.
In fact, there’s an old adage in cricket that if a team is batting and on a good score – to get a truer representation of how things are, you should add two wickets.
So if a team is 260 for the loss of four (out of ten) wickets, that looks pretty good.
But if you imagine two wickets suddenly falling, it can quickly become 260 for 6, and that’s much more precarious.
The whole mood changes.
You can feel the change in the atmosphere. Suddenly, the bowlers (the bears, in this analogy) get an extra spring in their step. They smell opportunity and put in that extra effort.
Batsmen (bulls) suddenly get nervous.
A very minor shift can completely change the game.
And through it all, the betting market swings from positive to negative, from one side to the other.
The same is true in the markets.
Mastering the market cycle
Last night my girlfriend, who is getting into investing with admirable enthusiasm, asked me why I thought this wasn’t a great time to buy stocks.
I chose not to bore her to sleep with my cricket analogy (I saved that for you, you lucky things).
But I did try to capture the cyclicality of markets with this little tale of the last ten years…
In 2009, everyone was scared.
We were in a recession, the banking system was broken, and markets had been cut in half.
Businesses were just trying to survive.
They weren’t taking on new employees, investing in new machinery or software to help grow their business.
They were just holding on for dear life.
Investors were scared after markets had fallen so far.
Most were happiest holding cash and were nervous about putting money to work.
Banks were unwilling to lend money to anyone, or unable.
But then a couple of years later, things have stabilised. A few brave businesses have started to borrow money to fund growth again.
Confidence begins to grow again. Investors start to feel safer, start deploying more capital into markets and start making more confident forecasts.
A few years down the line and the panic of 2009 is gone. Investors are bullish – stocks haven’t stuttered in six or seven years, why shouldn’t they be.
Even though the economy has only grown by a couple of per cent per year since 2009, stock markets have grown by 10% per year.
You could have bought a pound of profit for a tenner or less, back in the dark days of the late 2000s.
But now, for a pound of profit you have to pay £20.
People do though, and stocks keep rising at 10% a year even though the economy is only growing at one or two per cent.
And that has carried on to this day – the price of companies growing much more quickly than the companies themselves.
In the US, the bull market has been so strong that stock markets have never been this much bigger than the economy.
Almost twice as big in fact (191%).
In 2009, that figure fell almost as low as 50%…
You can see that chart and the data here.
Investors see prices going up, buy, and when they go up some more, it confirms what clever chaps they are.
Greed takes over slowly from fear until it is everywhere and all-powerful. People only think about prices going up, and this leads them to pay more and more for every pound of profit.
The stock market was half the size of the economy 12 years ago, now it’s double. The economy has grown slowly in a pretty straight line that whole time.
It’s psychology above all which has driven the market to these great heights.
Which is why my overarching framework is always based on psychology and the market cycle.
It moves rather slowly, so it isn’t that exciting to write about. But every now and again it’s worth reiterating why caution should be the watchword today.
Investors are greedy. They have seen prices go up for 12 years, and even rebounded in no time from the rapid Covid crash last March. But… to quote Howard Marks: “What the wise man does in the beginning, the fool does in the end.”
His book, Mastering the Market Cycle, is the best investigation of this phenomenon that I have come across.
To take it back to my sports betting analogy from earlier, you want to bet both ways, when the odds are in your favour. Bet on England when India are doing well, and when the match has turned, bet on India – getting very good odds in both direction. Buy low, sell high.
When the bulls have had their way for a long time, it’s probably fair to expect some disruption or change, and the bookies will offer you great prices to make that bet.
Once the pendulum has swung in the other direction, you’ll be able to bet on the other team.
The only notable success in recent times was betting on England about six months ago.
They had started as heavy favourites in a match against India. But India did brilliantly in the first half, so the odds shifted in their favour. But odds tend to be overly linear, and just at the moment when India looked at their most potent, I bet on England.
That happened to be the moment when the pendulum had swung to its farthest extreme.
It retreated from the extreme, but momentum is just as powerful in cricket as it is investment.
Psychology is powerful too, and once England got the wind in their sails, they grew in confidence. The pendulum gathered pace, moving to a point where the match was balanced, and then as in markets, it swung through the midpoint, and England ended up cruising to victory.
I think I won an almighty £8 that day.
In markets you want to be fearful when others are greedy. And you want to sell when prices are high – as they are today – and buy when they have fallen to low levels.
When the time comes to do these things, famously, you won’t want to.
And just because something is overvalued, doesn’t mean it’ll go down tomorrow.
But with the pendulum at such extremes…
I know where my money is.
Editor, Southbank Investment Research
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