Jonathan Davis column

Why do most expert investors say that you should pay no attention to what is happening to the overall level of the market? Two reasons stand out. One is the familiar argument that it is pretty nigh impossible to call the turning points in the market with any great precision. Market timing, as this approach is called, is simply too difficult to be a profitable concern. Someone like George Soros might be able to do it once in a while, though even he is far from infallible, if you look closely at his record.

Far better, for most investors, to keep investing on a regular basis in the market through a savings scheme, or something similar, and let the law of averages work in your favour. A number of studies have shown that most of the biggest movements in the market are concentrated in relatively short periods of time. Miss them, which you are more than likely to do if you are trying to move in and out of the market to time your purchase of shares, and you will probably miss the main reason for being in equities in the first place, which is their superior rate of return over the longer term.

For example, the fund management house Fidelity did a study which looked at how the market moved over the period from 1 January 1987 to the end of 1996, based on the assumption that you were investing in the FT All- Share Index.

It found that if you had remained fully invested throughout the whole period, which included the big market crash in October 1987, you would have had an average annual return of 14.16 per cent. If, however, you had missed just the market's 10 best days, the return would have fallen to 9.76 per cent.

If you had missed the best 40 days, the return would have been just 3.40 per cent. In other words, something like three-quarters of the return from the market was produced on just 40 days out of the whole 10-year period.

What's more, it also found that if you had become nervous about the level of the stock market at the start of 1987, sold all your shares and not bought anything back until the end of the year, your return by the start of 1997 would have been 142 per cent.

However someone who had ignored all the siren warnings and remained fully invested throughout 1987, up to and including the October 1987 crash, would today have enjoyed a return of 152 per cent.

The reason is that most of the big moves upwards in the stock market tend to happen either just before or just after the biggest falls. While this shows that market timing can in theory be highly profitable, the practical moral for most investors is that you had better be pretty good at it to have any hope of making money from it. The chances are that you may well end up worse off than you would otherwise be.

A second reason for not getting too hung up on what the market overall is doing is that the movements in the market you read about in the newspapers are often downright misleading.

What has happened to the stock market this year is a classic case in point. The market, you will keep reading in the papers, has had a bumper year, up 20 per cent since the start of the year.

But the question to ask is which market are we talking about. Take a look at these figures, produced by the analysts at BZW. In the 12 months to the end of June 1997, the FT All-Share index was up 17.1 per cent. Yet, as I pointed out last week, this masked a remarkable contrast between the performance of the biggest companies, as represented by the FTSE 100 index, and those of smaller companies. The Footsie was up 24.1 per cent, but the FT 250 index (of medium-sized companies) and the Small Capitalisation index were up by just 1.8 per cent and 1.6 per cent respectively.

What is more, the Footsie index itself has hardly been behaving in a consistent fashion. Two sectors - banks and pharmaceuticals - have accounted for almost the entire rise in the market over the past six months. If you did not own HSBC Holdings, Glaxo, Lloyds TSB, Shell or SmithKline Beecham shares, you would have missed all the fun. Of the 35 market sub- sectors tracked by BZW, half actually fell in value over the period.

The extraordinary run in banks has been the most remarkable feature of the year so far. A lot of things have contributed to it: the flotation of the demutalised societies, the Government's move to give up control over interest rates, the rise in the Hong Kong stock market ahead of the Chinese takeover and, most recently, an outbreak of takeover speculation.

So strong has the run in banks been that, coupled with the flotation of Halifax, Alliance & Leicester and so on, for the first time in living memory the total market capitalisation of the financials sector of the stock market has overtaken that of the general industrial sector.

There are, of course, plenty of sound explanations why banks are worth investing in in the current climate. Low inflation, rising short-term interest rates and falling long-term rates is about as favourable an environment for banks as you can hope to find (remember that when they give you a mortgage, the banks typically lend you long-term money at short-term rates).

I don't think that the bank share run has yet run its course. But this is an environment where almost any piece of news is interpreted as good for the share price: the troubles at NatWest Markets, for example, are interpreted as a sign that NatWest may face a takeover. This is usually a sign that a market has become dangerously overblown.

The underlying point to make, however, is akin to the one about market timing generally. Unless you feel that you are smart enough to spot which sector is going to make the biggest contribution to the index, you are probably better off not worrying about which sector is going to do best at all.

Put your money instead into a fund that gives you regular exposure to the whole market, and let someone else do the worrying.