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February 15, 2008

When is The Right Time to Buy Stocks?
by Prieur du Plessis

Global stock markets, and the US markets in particular, have displayed a large degree of volatility since the middle of last year and daily fluctuations are now back at levels last seen in 2003. This is shown clearly by the following graph of the daily change in the value of the S&P 500 Index.

Source: StockCharts.com

In the nature of stock markets, some investors seem ready to turn tail at the first sign of bad news. On the other hand, there are those who are only interested in knowing whether the current bear phase has bottomed so that they can buy stocks again.

This begs the question: When is the right time to buy stocks? Unfortunately there is no straightforward answer, irrespective of the amount of analysis thrown at the issue. But let's step aside from trying to time the market by simply considering what the chances would be of losing/making money on the stock market over different holding periods.

I have asked the research team of my investment firm, Plexus Asset Management, to conduct an analysis of the returns of the S&P 500 Index for different holding periods over the past 51 years (i.e. from the inception of the "new-look" S&P 500 Index in 1957 through 2008). Both price movements and dividends were included in the return calculations.

The following graph and table summarize the research results:

The analysis of the one-month holding periods indicated that 36.3% of all the periods resulted in a negative return and that 63.7% of all the periods therefore recorded a positive return. The best one-month period (September 1982) showed a return of 12.1% and the worst month (October 1987) a return of -21.6%, while the average monthly return was 0.9%.

It therefore seems as if the likelihood of a profit over the one-month period is better than the likelihood of a loss, but in view of a probability of 36% investors will still have a tough time knowing how the situation will play itself out.

Unless you have the proverbial crystal ball, why take the risk of investing in the stock market? It is for the simple reason that the situation looks significantly different over longer periods – the longer the investment term, the less chance of ending up in the red.

By increasing the investment term to one year, the picture already starts improving. 76.9% of all the one-year periods showed a positive return, i.e. 23.1% of these periods registered negative returns. Furthermore, the best one-year period (August 1982 to July 1983) showed a return of 60.2% and the worst (November 1973 to October 1974) a return of -34.2%. The average return was 11.9%.

As can be expected, investors fared much better over the five-year holding periods. A loss was made in only 8.0% of the periods, while the average return amounted to 10.8% per annum. The best period (September 1982 to August 1987) showed a return of 29.7% per annum, whereas the worst period (April 1998 to March 2003) recorded a return of -3.8% per annum.

Stretching the holding period even longer, not a single one of the 493 rolling ten-year periods produced a negative return. The average return for staying invested for ten years was 11.1% per annum.

The research results are not offered as an alternative to sound fundamental and technical models (or perhaps an experienced "gut") with a track record of having accurately identified entry or exit levels over time. It merely serves the purpose of alerting investors to the stock market's return profile over different holding periods in order to (1) know what they are "up against", and (2) properly match their investment personalities with investment periods that are optimal for allowing them a good night's sleep en route to an improved lifestyle.

Dr Prieur du Plessis
investmentpostcards.com

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

Copyright © 2008 Dr Prieur du Plessis

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