Market Comments April 2009 | Print |
Written by Tony Gray   
Thursday, 02 April 2009 14:00
The Global Financial Crisis continues to dominate the behavior of government, industry and consumers and a few of the following consequences are apparent:
  1. The world is in the midst of the first global recession since World War II;
  2. Credit remains scarce for many companies and individuals - not because there is a shortage of cash, but as many international banks are limited in the level of loans they can extend given their weakened capital base;
  3. Governments are supporting major companies that would otherwise go broke, since to allow default on loans may well trigger a domino effect that leaves otherwise sound companies fail due to counterparty risk from instruments such as credit default swaps;
  4. Further weakness in the Australian economy will occur - with one official at the Reserve Bank of Australia predicting declines until late 2009 and others, such as the CEO of ANZ, expecting weakness until mid 2010; and
  5. Australia is well placed relative to most other developed nations, with low government debt levels (relative to the size of the economy), lower unemployment, smaller budget deficit and only a modest decline in the economy expected.
A key positive is the strength of our banking sector.  The fact that most loans are on a variable basis and fixed terms rarely extend beyond 3 to 5 years means that the interest rate cuts to date have had a major stimulatory effect on the economy.  This has not occurred in the US for example, where loans may be fixed for 30 years and interest rates have barely changed for many with a mortgage.  This is one reason that local interest rates are unlikely to fall to the same extent as the US, Europe and Japan.  It also means that extreme practices, such as printing (or electronically creating) more money should not be necessary in Australia.

Australian residential property is a key risk to our economy - especially if unemployment rises too far and buyers are overwhelmed by forced selling.  To date this has not occurred and lower interest rates now make it an economic proposition to buy rather than rent (at least for the present).  Further, new supply of housing has been declining, so there is not a growing surplus of property to be absorbed (although I note that February housing approvals in fact rose).

It is our expectation that the Australian sharemarket will recover a full 6 to 12 months before the low point in the economy is achieved and that in the twelve months from the low point we may see very strong gains.  Every major bear market I have reviewed since (and including) the Great Depression exhibits the same characteristics - an end to a recessionary bear market occurs well before the economic low point and the greater the percentage decline during the bear market, the greater the percentage recovery. 

It is not all rosy though - I doubt very much that a recovery rally will then translate into sustained growth for a number of years.  I am expecting a very difficult period for investors over the next 3 to 8 years, with bouts of profit taking and investor unwillingness to pay high price to earnings multiples or make use of leverage limiting growth.  Further, the very low interest rates overseas, printing of money by many national governments and large debt increases at the government level make it likely that a period of high inflation will emerge within a few years.
 
In other words, we may well experience conditions similar to those that followed the 1973 to 1975 recessionary bear market.

Cash & Fixed Interest


In these circumstances, long-term investment in cash, term deposits or bonds may see increases in income returns (not in the short-term), but without the benefit of capital growth the purchasing power of this money will decline.  So whilst they serve as a safe haven at present, there is a longer term cost to holding too many assets in this area (relative to weightings as per your risk/return profile).

I am hoping to find that some inflation indexed bonds become available for investors over the next 12 months, which will pay a lower rate of interest but provide what may prove to be a significant inflation hedge.
 

Property


Listed property is a higher risk/return proposition at present levels.  Those groups with more debt and concerns about refinance, forced property sales, further falls in property values and possible administration also have the greatest recovery potential. More conservatively geared trusts trade at a lesser discount to asset backing (say one third!) and are a reasonable investment proposition, paying a decent income yield and offering some recovery potential. More aggressive investors may well collect a number of riskier trusts, potentially losing 100% of some investments for the prospect of 200%, 300% or 400% gains for those that survive.

The listed property market anticipates the physical market and the very large discounts to asset backing are a clear signal that commercial (industrial, retail and office) property values will fall in value. Just as with listed companies, a recovery by the listed trust sector will occur well before lows in the physical market are achieved.

International


I am wary of international assets, with overseas economies printing money and racking up debt, there is a reasonable chance that the Australian dollar strengthens, limiting the returns from this sector. Whilst some exposure is warranted for most portfolios, the lower income yield and currency effect suggest a lower than normal allocation to this sector.
It is also possible that commodities are seen as an inflation hedge and this also leads to a stronger Australian dollar? 

Australian Shares

 
UBS released on 20 March a report titled "Bear Markets, Bear Market Rallies and Market Bottoms".  The conclusion was: "that timing the bottom precisely is not necessary. If an investor can buy within a reasonable range of the bottom, returns are generally strong across 1, 5 and 10 years despite a commonly held view that periods like the 1930s and 1970s were dead money periods for equities." 

Investing more funds in Australian shares at the present time depends very much on your existing allocation within the ranges recommended for your risk/return profile. For those underweight this sector, whilst there are risks of further short-term and potentially sharp falls in asset value, the medium to long-term returns from the present level are likely to be strong.
 
Individual stock selection is always an issue and the safest course of action is to aim for a diversified portfolio. This may not suit more aggressive investors who are more willing to run concentrated portfolios.

Summary

 
Regular communication is encouraged and we will be improving our reporting of portfolios and investment recommendations over the coming months. There are significant gains to be made from the lows of this bear market; we do not know if the recent rally signaled the end of the bear market or if prices trend down for a period measured in months (not years). I have no doubt that economic news will worsen for some time yet and keep many investors on the sidelines.

Please treat the above comments as General Advice, with no action to occur in reliance upon these statements until we have considered in the light of your financial position, needs, goals and objectives.
 

Portfolio Management


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