Adriaan Pask, Chief Investment Officer at PSG Wealth

In the dynamic world of finance, where markets sway to the tune of economic indicators, geopolitical shifts, and investor sentiment, predicting the future can seem like a daunting task. Markets, like much in life, are not predictable, yet amidst this uncertainty lies a beacon of guidance: historical trends. While markets remain inherently unpredictable, understanding the lessons of the past can arm investors with invaluable insights to navigate the twists and turns of the financial landscape.

What to look for when considering historical trends

Identify patterns

Although the future trajectory of markets remains shrouded in uncertainty, historical data often unveils hidden patterns and trends. By delving into past market cycles, young investors can glean a deeper understanding of how markets have reacted in analogous situations. These insights can assist them in identifying recurring patterns that may offer clues about future market movements, providing a valuable foundation for informed decision-making.

Learn from past mistakes

Market history serves as a rich tapestry woven with tales of exuberance and despair. From the dot-com bubble of the early 2000s to the housing market crash of 2008, each chapter offers priceless lessons. By studying past market crashes and corrections, investors can discern the warning signs of speculative bubbles and systemic risks.

Build resilience

Volatility and uncertainty are integral facets of financial markets, and market history serves as a testament to this. Understanding historical trends can cultivate resilience and emotional fortitude to weather market downturns. Armed with the knowledge that market downturns are often followed by recoveries, investors can resist the temptation of panic selling and maintain a steadfast course towards their investment goals.

Adapt investment strategies

Historical data provides a roadmap for tailoring investment strategies to prevailing market conditions. Analysing the performance of different asset classes across various market cycles can help with fine-tuning investment strategies to align with risk tolerances, investment objectives, and time horizons.

The cyclical nature of markets

The cyclical nature of financial markets mirrors the ebb and flow of tides, featuring alternating phases of expansion and contraction driven by a complex interplay of economic factors, investor sentiment, and geopolitical events. During periods of expansion, optimism prevails, which propels asset prices higher and fosters economic growth. However, this optimism eventually yields to caution as markets reach their peak, triggering a contraction phase characterised by heightened volatility and declining asset prices.

However, downturns also bring opportunities as markets recover and enter a new growth phase. Understanding and navigating these market cycles is essential for young investors venturing into the ever-changing landscape of finance. By recognising these cycles and preparing mentally and financially for inevitable downturns, they can capitalise on opportunities that arise during periods of market expansion. Moreover, understanding market cycles empowers investors to adopt a long-term approach, resist the allure of short-term speculation, and make informed decisions that align with their investment objectives and risk tolerance.

Economic factors

No matter the generation you belong to, it’s crucial to consider various economic factors when making investments today:

• Interest rates

Low interest rates may stimulate economic activity and boost asset prices, while high rates can dampen growth and weigh on profitability.

• Inflation

Investors should monitor inflationary trends and consider assets that offer protection against rising prices.

• Growth outlook

Assessing indicators like GDP growth, consumer confidence and business sentiment can provide insights into the trajectory of economic expansion or contraction.

• Fiscal and monetary policy

Changes in fiscal policy, such as tax cuts or stimulus packages, can have varying impacts on different sectors, thereby shaping investment opportunities. Meanwhile, monetary policy (driven by central bank actions like interest rate decisions and quantitative easing measures) directly impacts liquidity conditions and asset prices.

• Currency movements

Exchange rate fluctuations impact the competitiveness of exports, corporate earnings from foreign operations, and the returns on international investments.

• Employment data

Strong employment data may fuel consumer confidence and drive economic growth, while rising unemployment could signal economic weakness.

By assessing these economic factors and their potential implications for financial markets, investors can make more informed decisions and navigate the complexities of today’s investment landscape.

Trends in asset class behaviour

Historical trends in the behaviour of different asset classes reveal valuable insights into their volatility, returns, and other key characteristics, as explored below.

Stocks

Stocks have historically shown higher volatility than other asset classes and have displayed significant price swings – notably during events like the 2008 Global Financial Crisis (GFC), where the S&P 500 index dropped by over 50%. However, despite such short-term turbulence, stocks have delivered strong long-term returns, averaging around 10% annually.

The cyclical nature of the stock market is also evident in events like the Great Depression. In 1933, despite economic despair, the market surged by almost 54% after government intervention restored confidence and stimulated economic recovery.

S&P 500 historical returns (1874 to 2023)

Bonds

Despite typically offering lower returns than stocks, bonds have been shown to provide steady income and capital preservation. For instance, US Treasury bonds have historically delivered average annual returns of around 3% to 5% over the long term. They can still undergo price fluctuations, however – especially in response to changes in interest rates.

Real estate

Real estate investments generally offer relatively stable prices compared to stocks and bonds, but are still prone to cyclical fluctuations influenced by factors like interest rates, supply and demand dynamics, and local market conditions. During the subprime mortgage crisis in the late 2000s, housing prices in the US experienced significant downturns, resulting in widespread foreclosures and the collapse of the real estate market. Be that as it may, real estate has historically provided attractive long-term returns. US home prices have appreciated by approximately 3% to 5% per year on average over the past several decades.

Commodities

Commodities provide excellent diversification and hedge against inflation, though their returns are erratic and influenced by market sentiment and macroeconomic conditions. For example, oil prices fluctuate sharply due to geopolitical events, as seen during the Covid-19 pandemic and the 2020 oil price war. On the other hand, commodities like gold can perform well during periods of high inflation, protecting purchasing power and enhancing portfolio value, as evidenced by their surge during the GFC.

Remember the power of compound growth

The concept of compound growth in investments is a powerful force that allows investments to grow exponentially over time. Compound growth occurs when the returns generated from an investment are reinvested to generate additional earnings, leading to a compounding effect that accelerates the growth of the investment.

The power of compounding

Source: New York Retirement News

Over time, even small initial investments can grow significantly due to the compounding of returns. This phenomenon highlights the importance of starting to invest early and consistently adding to investments to maximise the benefits of compound growth. By harnessing the power of compound growth, investors can potentially achieve their financial goals more quickly and build substantial wealth over the long term.

ENDS