When investing, patience is almost always a virtue. But if you’re an investor in share-based funds, your patience has probably been sorely tested over the past year. The damage done by the sub-prime/‘credit crunch’ crisis has caught almost everyone by surprise.
My concern is that investors who managed to ‘hang tough’ in the face of the initial slump may finally be losing patience and looking for the exit.
While every investor’s situation is different, I believe investors should try and maintain composure and stay invested. Here’s why:
While it’s very difficult to time when markets will rebound, they respond so strongly after a big decline because they tend to be oversold as people panic about losing money. This means that stocks are indiscriminately sold. Eventually, however, the tide of negative sentiment exhausts itself. At this point, emotions start to settle, true value emerges in the market and the pendulum of sentiment starts to swing back in a positive direction. This is when professional investors like BT see an opportunity to benefit from the market bounce - a chance to buy quality assets at bargain prices.
That’s the logic and the data behind the ‘bounce back’. It may be enough to convince you that patience is still a virtue. If not, you might want to remember that over the past ten years the Australian share market, as measured by the S&P/ASX 200 Accumulation index, has delivered a total return of 171% (to end September 2008). While the future is always uncertain, investment history can also be a comfort for patient investors with a long-term time horizon.
One of the world’s greatest investors, Warren Buffett, has a very simple adage when it comes to making money and that is to 'be fearful when others are greedy and greedy only when others are fearful’. A very salient reminder for investors during times like this.
I hear a lot of people say that perhaps this time will be different - that we are heading towards a recession, or even a depression, an economic climate that the world hasn’t seen since the early 1930s. While there is no doubt that the economic climate will be very tough over the next 12-24 months, I don’t think we are in for a sustained economic downturn. The Australian economy is in good shape and there is plenty of scope for the Government to continue to cut interest rates to ensure that consumer spending doesn't dry up completely.
To stay informed with the latest markets news and tips on investing during uncertain times, make sure you regularly visit bt.com.au/volatility. We hope these insights give you a comprehensive view of what's going on and help you make better investment decisions.
Rob Coombe
Chief Executive Officer
What an awful week. What a shocking month. What a terrible year it has been for investors. I don’t anticipate a worse one in the rest of my working life! It says something when you’re grateful that the Dow Jones is off by just 1.5%, as it was two days ago. Such was the continued volatility that it traded over a 1000-point range on the day. For the week, the Dow and the S&P 500 both fell by 18.2%, while the Nasdaq was down by 'only' 15.3%. The US share market first reached its current level as long ago as 1997. And, of course, the Australian share market had its worst day since the 'Crash of ‘87', falling by 8.3% on Friday, to be down by 15.6% in the week.
Clearly market participants have convinced themselves that the recessions are going to be both long and hard, so they are withdrawing now. They may be right about the severity of the downturn. On the other hand, we may look back at the 'Panic of 2008'.
This extreme volatility has affected other markets also. Who would have believed three months ago, when oil was $147 a barrel, that it would now be less than $80? Or, perhaps most amazingly, that the Australian dollar would have fallen from an over-valued 98 cents to a ludicrous 65 cents? Last week saw the Australian dollar move by more in a single day than it has at any time in the past 25 years, the period over which we have had a floating currency. Who is selling the Australian dollar at 65 cents? Both of these extreme movements reflect a reassessment of likely world economic growth in 2009.
With so many OECD nations (those countries which form part of the Organisation for Economic Co-operation and Development) already experiencing close-to-zero growth, it is beginning to sink in that we may be on the brink of world recession. The International Monetary Fund (IMF), for example, last week revised its 2009 world growth forecast from 3.9% to 3.0%, with the developed economies expected to grow by just 0.5%.
It is clear that we are somewhere that we have never been before. Financial systems around the world are 'locked up', with institutions completely unwilling to lend to each other for fear of what could happen next. A problem that began with a cavalier attitude towards, and a severe underpricing of, risk has led to a situation where the major players are unprepared to take any risk. This is prudent behaviour on the part of the individual institution, but it drives the price of assets down further, and constricts economic activity, both of which exacerbate the problem further. The world economy is caught in a brutally vicious circle.
The remedy is a circuit-breaker of some kind, and policy-makers around the world are desperate to find one. In fact, it will take more than one. We will see interventions in the days and months ahead that would never have been imagined in a functioning capitalist system. Bank deposits have been guaranteed in Australia, and governments will purchase equity in financial systems all over the world. We will see stronger government controls than anyone would have envisaged a few years ago; firstly to stabilise the situation and then to ensure that it never happens again.
Trying to pick the timing of a halt to the current carnage is difficult. But I would make the following points. The fall in the current bear market in shares is already bigger than the average for such episodes. The Australian market is more than 40% below its peak; the average bear-market fall is about 33.3%. Also, if measured by conventional price/earnings ratios, share markets around the world are very cheap right now. Price/earnings ratios can mislead; they are only as good as the underlying earnings forecasts. But right now, world equity markets would be fairly priced (neither cheap nor expensive) if earnings were to fall by more than 40% next year. Do we really think that the crisis will be that bad? Remember that this is a very different episode from the worldwide bear market that began in 2000, from a position in which equities were ridiculously overpriced.
One rarely sees sustainable recoveries in share markets until economists and analysts start to factor in economic recovery (this process precedes recovery itself by several months), and we are months away from that. So we seem to know the following: markets are cheap right now and there is a sustainable recovery out there somewhere. We just don’t know whether fear and pessimism will become even more dominant in the weeks ahead. That said, there has to be a chance of a short, sharp rally in the coming weeks if market participants come to the conclusion that the market is oversold. I have been wrong on this before, I admit, but my personal view is that it is now 'too late too sell'.
The fall in the currency has been amazing. 'Fair value' of the Australian dollar has probably fallen from about 90 cents in July, to about 78 cents now, so the currency has gone from too expensive to way too cheap. This means that it is likely to claw its way back up to the high-70s over the months ahead. This is good news for overseas travellers, but not so good news for investors. The falling currency in recent months has shielded investors with money offshore (and we all have money offshore!) from at least some of the market carnage. A rising $A in the months ahead will subtract from some of the future gains from investing abroad.
Chris Caton
Chief Economist
However, the resilience of growth largely depends on whether consumer contingence returns sufficiently to prevent a sharply domestically-driven slowdown. On balance, we expect that the economy will sustain growth at 2.5 to 3% through 2008/09, but calendar 2009 will see growth weaken further as a result of a gap in building activity. However this gap will increasingly be filled through 2010 by an upswing in dwelling building as confidence returns and lower interest rates encourage the release of significant pent-up demand for housing.
Residential market conditions across most of Australia's capital cities peaked during the second half of 2007, before price growth eased in the first half of 2008. Home affordability, which was already constrained by solid price growth and four 0.25% interest rate rises over the eighteen months to December 2007, deteriorated further due to the housing variable rate increasing by 0.9% in the six months to June 2008. Subsequently at June 2008, affordability levels were the poorest they have been since 1989 in Sydney and Melbourne, while in all other capital cities, the deterioration in affordability had surpassed previous highs.
This has led to a considerable weakening in demand for residential property, highlighted by the fall away in demand by both owner occupiers and investors. Nationally, the number of owner occupier loans declined by 18% over the six months to June 2008, compared to the six months to December 2007, while the value of loans to investors fell by 15%.
As a result, only Adelaide experienced an improvement in median house price growth in 2007/08 compared to the previous year, while Brisbane witnessed very similar price growth. Although easing, price growth was still solid in Melbourne, Hobart and Darwin in 2007/08, while it was much more moderate in Canberra.
In Sydney and Perth, housing affordability had already reached its limitations prior to 2007/08, providing little scope for price growth during the year. Subsequently, these two capital cities experienced the lowest median house price growth in 2007/08, with median house prices in Perth even declining slightly over the year.
Despite a 0.25% cash rate cut in September 2008, and another 0.25% reduction in the first half of 2009, poor affordability is expected to remain a major constraint to price growth in 2008/09. Consumer confidence is likely to be further dampened by a mild slowing in economic conditions causing a rise in the unemployment rate. With purchaser sentiment weak, median house price growth in all capital cities in 2008/09 is forecast to be lower than that attained in 2007/08, except for Perth, which is projected to achieve minimal growth after house prices declined the previous year.
Moderate to low price growth and two interest rate drops forecast over 2008/09, combined with a further 0.5% fall in housing variable rates projected in 2009/10, is expected to improve housing affordability. At the same time, high population inflows from overseas migration are expected to underpin a further strengthening in underlying demand, which is already outpacing new dwelling construction, and is forecast to continue to do so in the three years to 2010/11 in most capital cities.
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