C&B Notes

Top-Down Mistakes

We are adherents to the idea that an investor “should be greedy when others are fearful, and fearful when others are greedy.”  However, as Credit Suisse’s annual Global Investment Returns Yearbook illustrates, (1) it is not enough to simply be a contrarian, and (2) top-down investing on a positive long-term trend is fraught with permanent capital risks. Unfortunately or fortunately, investing cannot be made simpler than it actually is.  Like most investing rules, buying the dip works until it doesn’t.

This year, the academics tried to address their concern that their global stock market index suffered from “survivorship bias”.  So they have recalculated them including three new countries that were not previously covered in their attempts to calculate the global equity risk premium: China, Russia and Austria.  Adding these nations hugely changes the perception of long-term risk.

Let’s start in Russia. Any bold contrarians who decided in the late 19th century to bet on Tsarist Russia to outperform the U.S. for the long-term, and held on even during the great political unrest of the attempted revolution of 1905, would for a long time have looked very clever.

The chart compares the St. Petersburg stock exchange’s composite index performance with that of New York. After 1917, of course, the value of any equity investment in Russia was wiped out.

This might appear to be an exceptional example.  But it is not. China also had a revolution that led to the closing down of its stock market (and of capitalism for a while), and that happened within living memory.  On the eve of the second world war, China’s returns looked very healthy. With the arrival of Mao, shares went to zero (and international investors have had a rough ride even since Chinese stock markets reopened).

Using the MSCI China index, covering stocks available to international investors, those who bought in 1993 have actually lost money.  But Chinese stock markets have been recovering recently. And, deliciously for those who like historical ironies, the Shanghai Composite, the main domestic index, bottomed last year at 1949, the year of the revolution.  Results almost as catastrophic for investors can happen even to countries that do not succumb to a violent revolution.  For evidence, look to Austria.  In 1900, Vienna was the seat of a great empire, and Austria accounted for 5 per cent of global market capitalization.  Austria’s stock market is now so small, in global terms, as scarcely to be visible to the naked eye.

Dimson, Marsh and Staunton now have 20 countries with continuous stock market histories going back to 1900, and Austria’s performance has been by far the worst.  Anyone investing in their bonds or their bills in 1900 would by now have lost more than 99 per cent of their money (although of course in several countries, including Germany, investors lost 100 percent).