How to invest when markets go sideways

Sideways market
 
Sometimes markets don’t go up or down, they go sideways. Sideways markets can last weeks or even years. They can be particularly frustrating for a long-term investor.

As time passes and markets don’t go anywhere, it can be tempting to change your investment strategy or switch into cash. However like driving in heavy traffic, switching lanes is unlikely to get you there faster. The best investors resist the urge to change strategy during these times because they understand the secret to sideways markets.

Markets simply don’t go up in a straight line. They tend to overshoot and then flatline rather than go up at a constant rate. Think of markets like a coil, constantly being compressed before springing back to life.

ASX200 - long term trend

As you can see, the general trend for Australian shares since 1992 has been upwards however there have been stretches of time when shares have gone nowhere. From 1999 to 2002 markets were flat. Then between 2003-2007 the market more than doubled. Since 2007 shares have been playing catch-up for a decade – Australian shares are still below their nominal high of 2007. The spring is being compressed again.

Markets rarely return to their long run average for any extended period of time. Instead they tend to overshoot to both the upside and the downside. We’ve written about this before in ‘How reliable is past performance?’.

How to invest during sideways markets

Our best advice for investing when markets are going nowhere is not too different to when markets are rising. Focus on asset allocation, rebalance periodically, keep costs low and avoid the temptation to get in and out based on market commentary.

Here are some other factors to keep in mind when markets have no short term trend:

Focus on dividends

Dividends can make up most of your returns in sideways markets, so don’t forget them. Over the past 12 months to August 2017, the Stockspot Topaz portfolio has generated dividends of 3.63% and capital returns of 2.33%. Dividends have therefore accounted for 61% of the total return of 5.96%.

Diversification helps

Think outside of Australia. During the 2010-15 period that saw poor returns for Australian shares, other developed market shares in the US, Japan and Germany were up over 80%. This is why 30% to 55% of the Stockspot portfolio growth assets are invested outside of Australia.

Performance of global indices

In the short-term, diversification means being disappointed with some parts of your portfolio. However you won’t be disappointed with your portfolio over the long-term which is the only time frame that really matters!

Rebalancing and re-investing dividends

In periods of choppy sideways markets, the best way to buy low, sell high and keep your risk level consistent is through rebalancing. This is part of what we’re continually managing for clients.

Remember, sideways markets can be a friend in disguise if you are still in the accumulation phase of your life. You can buy stocks at lower prices rather than constantly buying higher and higher as markets rise.

For example, here are 2 different markets over a 5 year period. Both start and end at the same point. Which would you rather have invested in if you were periodically topping up your portfolio over the entire period?

Market A
Market B

Market A may look more appealing at first glance but in fact market B would have given you better returns. Dollar cost averaging is the reason market B yields the best results because you were able to buy more at lower prices while the market was going sideways.

That’s the secret to sideways markets!

Avoid the noise – don’t let market commentary send you off track

Finally, don’t allow market commentators influence your investing when markets are going nowhere.

Don’t let others talk you out of a good investment process just because they don’t invest the same way as you.

With no strong market trend, investment strategists and media commentators don’t know what to make of this market and the headlines reflect this confusion. This back-and-forth has led investors to believe that it’s been an unusually volatile year with headlines like these:

Financial news headlines

In truth, markets have been far from volatile this year and the past 3 months have just gone sideways.

ASX 200

It has actually been the least volatile year in history. During the first 100 days of 2017, the US market has had the smallest average daily moves since records began in 1970!

Sideways markets are great for long term accumulators. They’re not great for ‘market experts’ trying to call a short term trend. That’s why they tend to exaggerate any move that does happen, no matter how small.

Notwithstanding, you should learn to accept a level of volatility. Investing requires you to accept some form of volatility to earn a decent return on your money. There’s always an element of risk if you invest, the goal is to figure out which risks you’ll be rewarded to take and which ones are unnecessary. For example, buying individual shares is an avoidable risk when you can invest with diversified ETFs, like we do for clients.

Markets might go sideways but you can stay ahead

Sideways markets can be frustrating but the secret is to maintain your investment process. Patient investors who stick to their process and ignore the noise are the ones who will be rewarded over the long run.

 

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Chris Brycki

Stockspot Founder and CEO