“Everyone has a plan, until they get punched in the mouth” – Mike Tyson
I’ve been investing seriously for nearly two years now. In that time the FTSE All-Share index has returned 16.9% (minus dividends), and I have been fortunate in that my portfolio currently stands up over 40%. But we are currently in year eight of a bull market and, like many, I am yet to experience a severe draw-down in portfolio value. I have yet to be punched in the mouth, so to speak.
‘This Time is Different’
I don’t know if there’s a definitive way to prepare yourself for the inevitable. We like to believe ‘this time is different’, but it’s rarely the case. Irving Fisher is famously quoted as saying stocks had reached a “permanently high plateau” on October 17th, 1929. Exactly one week later, the market dropped 11 per cent in one day. Four days later, it lost 13 per cent, followed by another 11 per cent the day after that.
History is littered with examples of this kind of thinking. A few years ago, an article on Zerohedge enumerated 20 separate statements from 1927-1933 alone. So one thing we can do is attempt to accept this inevitability. Not only will there be a substantial decline in share price values, there will likely be many over the lifetime of a novice investor. However, accepting it and dealing with it are two different things. I can be quite happy with a 40% gain, but a 40% loss will hurt that much more. The psychological pain will be that much greater. This notion was best expressed by research performed in the 70’s by Kahneman and Tversky on what they termed ‘Prospect Theory’ (read more about Prospect Theory here).
So I’ve been giving thought to how best I can try to prepare myself for a large draw-down, and it occurred to me that part of the problem is that I’m thinking in abstraction. A theorised overall decline of 50% is too simplistic a notion to allow me to fully comprehend what awaits. I need to be more granular in my approach. So my idea is this: Look at some of the constituents of my portfolio and see how they fared during the last substantial decline in 07-09.
I concede this isn’t a perfect solution. As Mark Twain is supposed to have said, “history doesn’t repeat itself, but it does rhyme’. The price declines of the past will not be the same as those we’ve yet to face, and a business that weathered one storm may react differently to another. It’s not ideal, but it will help provide some indication of what to expect.
Avon Rubber PLC
’07 high = £1.88
’09 low = £0.28
07-09 peak to trough decline: 85%
Time to subsequent recovery: 22 months
Berkeley Group PLC
’07 high = £18.92
’09 low = £6.82
07-09 peak to trough decline: 64%
Time to subsequent recovery: 56 months
’07 high = £2.76
’09 low = £0.93
07-09 peak to trough decline: 66%
Time to subsequent recovery: 19 months
Howden Joinery Group PLC
’07 high = £1.65
’09 low = £0.13
07-09 peak to trough decline: 92%
Time to subsequent recovery: 45 months
’07 high = £15.26
’09 low = £2.30
07-09 peak to trough decline: 85%
Time to subsequent recovery: 60 months
Some nasty numbers in there, I think you’ll agree. Obviously I didn’t include every company in the portfolio as some weren’t listed in ’09, whilst others actually gained in value during the financial crisis. So what can we make of this information?
If you were unlucky enough to buy in at the top, you faced some very disheartening waiting periods to get back to break-even. Five years, in the case of Persimmon. This shows for me the very importance of a buy and hold strategy. Look at Diploma, for example. If you’d bought at the top, you’d have lost two thirds in value during the crisis. Psychologically straining, to say the least. However, had you held on through this and continued to own them today, you’d be up 316%. A very healthy return:
Diploma PLC – 316%
Avon Rubber PLC – 909%
Berkeley Group PLC – 74%
Howden Joinery Group PLC – 153%
Persimmon PLC – 56%
History doesn’t repeat itself, but it does rhyme. Buy quality businesses, buy them at decent valuations, hold on to them for dear life and you might just be OK. And if you get punched in the mouth, you can still recover. It just might take a little longer than you’d hoped.
If you’d like to discuss anything contained in this article, contact me on Twitter @britishinvestor, or leave a comment below.
Disclosure: AVON, PSN, BKG, HWDN & DPLM are constituents of the portfolio.