The above chart shows the 10 year performance of the S&P500 (blue bars) versus the 10 year average annual inflation (red bars) versus the Shiller PE Ratio at the start of each decade (green bars). There are several notable observations…
- The worst performance was during the 1930s when the US experienced a deflationary environment and PE ratio started very high
- The second worse performance occurred 2000-2009 when PE Ratios started through the roof (> 40) and contracted
- Other poor performances typically related to high inflation (1913-1919; 1970-1979) and/or PE ratio contraction (1940-1949)
So what do we start 2010-2019 with? A very high Shiller PE Ratio (~20.1), third highest to the start of the Great Depression and Tech Wreck/GFC decades. And, an outlook for inflation that is relatively low due to the very high unemployment that is expected to stay around for some time. The US economy has just seen an economic bounce largely on the back of inventories that are being built back up but this is not a sustainable growth driver and certainly from a sharemarket perspective not a justification for a high PE.
Whislt the US Economy recivers for decent sharemarket returns there needs to be some stronger growth drivers and what these drivers will be is a little unclear.
I just read that the Henry Review is likely to suggest that superannuation can be exchanged for guaranteed lifetime income like lifetime annuities. Strangely, it can be done already by purchasing a lifetime annuity with superannuation money. The problem with the current situation is that there are no lifetime annuities left on the market….Comminsure and not much else.
Hopefully this initiative re-opens competition for this outstanding product, except, instead of the current situation, hopefully the new products are priced appropriately. Yields for lifetime and long term anunities have a long way to go to be attractive.
Source: Reserve Bank of Australia
The government bond yield curve certainly expects another 50bps in RBA hikes this year with bonds yielding in the second half of this year trading around 4.3% to 4.4%. But since the start of the year the yields in longer term bonds have declined a little…this indicates a slight drop in confidence of the Australian economy this year.
As has been widely published, the Australian economy has performed relatively well compared to other developed nations around the world and this is largely thanks to the strong links of the Asian developing economies and their continued hunger for our commodities. With China starting to tighten its credit belt a little there is no cause for alarm, but complacency is not appropriate.
In a week or two, the half yearly reporting season begins and after a few months of relative lack of volatility, I’m sure reporting season may well change that. With US, Japan, and much of Europe in a little economic disarray, the risks still exist, so it should be another interesting year for investors.
Yesterday Morningstar released their investment performance league tables for each of the major asset classes for the Australian market. For almost every asset class in 2009, a higher proportion of active manager outperformed the index funds, like Vanguard, than underperformed.
Vanguard’s 1 year performance rankings for each asset class are…
- Australian Shares – 55th out of 99
- International Shares (Unhedged) – 55th out of 77
- International Shares (Hedged) – 10th out of 16
- Australian Fixed Interest – 27th out of 30
- International Fixed Interest (Hedged) – 18th out of 20
- Australian Property – 21st out of 34
- International Property – 10th (Hedged) and 24th (Unhedged) out of 27
Now these performance rankings by Vanguard are pretty bad as they are expected to perform around the middle of rankings, but a couple of things need to be kept in mind. Firstly, risk was rewarded in 2009 with significant growth in small cap equities and credit securities…the index funds are biased away from these and more conservative in nature and the performance tables are not adjusted for these risks. Secondly, these league tables always have a survivorship bias towards the winning funds…funds all around the world as well as in Australia disappeared during 2008 and 2009.
After the disaster of 2008 there was an enormous shift towards passive managers after numerous active managers fell over. Given the outperformance by active managers in the Morningstar league tables, will we see a shift out of passive and back into active in 2010?
I found this video one of my favourite blogs….www.calculatedrisk.com .
“The only people who have recovered from the financial meltdown are the ones who caused the financial meltdown”…John Stewart
Click here.
I started reading this week’s Economist mag yesterday and the lead article is about the asset bubbles that are appearing all around the world thanks to low interest rates. Article can be found here for subscribers.
In terms of housing the article suggested that the US is at fair value, whilst Britain is 30% overvalued, and Australia, Spain, and Hong Kong are 50% overvalued based on the current level of rental yields. Commodities were mentioed as being overvalued and as with my last post, so too are Emergin Markets.
“Today the prices of many assets are being held up by unsustainable fiscal and monetary stimulus. Something has to give”
I guess I’m off to a bearish start to the day today.
There’s an excellent article in the 12 Jan Financial Times on investing in emerging markets…found here. The basic message is that there is no correlation between GDP Growth and stockmarket performance, in fact its slightly negative if anything, so be wary when investing in emerging markets.
According to Professor Jay Rittner of the University of Florida,
“Countries with high-growth potential do not offer good investment opportunities unless valuations are low”
Another interesting point made was that in fast growing economies, the companies that end up winning the race may not even be known yet.
“In the 1950s there were more than 100 motorbike companies. The market leader was driven out of business by the cut-throat pricing of a flaky upstart called Honda”
The conclusion in terms of value is that the biggest emerging economy of them all, China, is in a current bubble and valuations are far from low, in both equities and real estate, where valuation metrics are above what Japan was at its peak in 1990. What is frightening with regards to China’s valuations, is that twenty years after Japan’s peak, its equity market is still trading around 70% lower.
Bottom line, be careful of investing in Emerging Markets and secondly, don’t forget Australia’s current reliance on China as any bust could be catastrophic for both our economy and markets.
We have seen numerous investment trends come and sometimes go over the last X number of years whether it be technology, commerical property, Buffettology, CDOs, high yield, hedge funds, mortgage funds, etc, but at the end of the day a balance of the key investment risks wins through….i.e. the risks relating to equity, liquidity, interest rates, credit, currency, and inflation.
These are my current thoughts on these risks and some investment themes…
- Liquidity Risk – forgotten for many years (particularly by the MTAA Super fund, and mortgage investors…remember Estate Mortgage???) but it still exists…forget chasing returns and having liquidity at the same time!!! Know what liquidity you need and hold CASH…not the so-called liquid Asian High Yield securities Basis Capital used for liquidity or even Enhanced Cash funds…CASH in a bank or pure Cash Management Trust that get’s it returns from 11am, government securities, and bank bills.
- Equity Risk…guess what? equity risk doesn’t just turn up in…equities! It can also be found in corporate bonds, hybrids, hedge funds, property securities, and many others…it is essential to understand the true equity risk a portfolio has and don’t push some of that risk into the more conservative asset classes like fixed interest. Equity risk can be scary, is required for growth, and shouldn’t substitute for anything else…like…an inflation hedge!…investing in equities is often a poor hedge to inflation as the 1970s showed…high inflation is not good for equity performance at all
- Interest Rate Risk…too many have ignored this one…but it can work in your favour in a crisis and can provide some portfolio stability…stockbrokers should try them some day…the whole “everything correlates to one in a crisis” is absolute rubbish…during the global financial crisis, those who diversified their portfolio with pure interest rate risk (i.e. little to no credit risk) from boring government bonds or conservative bond funds received double digit returns from this risk. During a crisis, investors run to quality and boring government bonds are just that…why don’t retail investors want to invest in quality???
- Credit risk…in times of crisis this is highly correlated with equty risk…as a result when building portfolios ensure your credit securities do not result in overweighting the exposure to equity risks. However, always keep in mind that credit securities have a negatively skewed return distribution…limited upside with massive downside…so why not just invest in equities instead and leave the fixed interest to boring governemnt bonds???
- Currency risks…what’s the Australian dollar going to do? Answer…absolutely no idea. So what to do? Being unhedged was favourable during the GFC as Yen carry trades returned to Japan and the flight to safety went to the US (yep….good ol’ Australian currency wasn’t considered that safe!). So perhaps unhedged is the go…however, the reverse was true in the recovery…market timing is very very difficult so if you don’t know, and I don’t, perhaps 50% hedged, and 50% unhedged is the go for global share allocations. Its difficult to invest in international bonds without being hedged to the Australian dollar…I guess if you want ot investin bonds for their safety and income then currency risk removes the safety aspect and perhapd hedged is best.
- Inflation risks…this is my favourite…bonds are best during deflation but the only investment that (hopefully) guarantees strong performance during high inflation is INFLATION LINKED BONDS!!! Governments around the world, including Australia, are issuing more…woohoo!…let’s get on board and reduce inflation risk from our portfolios. Life companies issue inflation linked annuities also…let’s look at them as well.
- Commodities can also can be a good inflation hedge also but they certainly carry a few other risks but are worthy considerations as they provide diversification with other asset classes. The only thing with commodities is…they mostly supply and demand driven!…there’s not really much added value there, so…good luck with picking supply and demand!!!
- Hedge Funds…these guys carry equity risk and/or credit risk…when markets crash…SO DO Hedge funds…the marketing myth of positive returns in any market has been exposed by the GFC and there’s two other things…its very very difficult to get your money out and their fees are so big that they have to take on significant risk to get the return…but at the end of the day if you don’t know how a fund invests you don’t know the risks so…don’t invest
in hedge funds!
- Emerging Markets…all the rage because of their economic growth…guess what…there is no evidence that shows high returns from countries displaying high economic growth. If Emerging markets aren’t in a bubble today…they probably will be tomorrow…so proceed with caution.
- Mortgage funds…they’re gone for a long time
- Australian economy…had an amazing run and is the leading economy in the developed world but keep this in mind…we’re basically a hole in the ground and reliant upon commodities. If the emerging economies falter and decide to stop buying our commodities then look out Australia…things may not be so rosy…just keep it in mind…and stop being so complacent about the Australian economy…I know you are so stop it!
- Property…I think I need a new Post for this one! Stay tuned
It appears there is a breakdown in the relationship between unemployment and house prices. I hazard a guess that its due to the low home loan interest rates we currently have (see my previous post) but given it appears the Reserve Bank looks like increasing rates further this year, for how long will this breakdown last?…probably not too long…my guess….house price growth is unlikely to be sustained and the property purchaser needs to be careful.
Source:RBA
The above chart shows the changes in interest rates since the start of 1997 for 3 different bank loans…
- Credit Card Interest Rates
- Personal Loan Variable Interest rates
- Home Loan Standard variable interest rates
Now, over the past 18 months we have all heard about ow the banks have not been passing on all of the RBA interest rates cuts and passing on even more than the RBA’s interest rate increases. This piece of information relates to the Standard Variable home loan rates which as the green line shows, as at the end of November, is at roughly the lowest levels since the beginning of the chart in 1997.
Unfortunately for those stuck in the debt trap of the personal loan or credit card, interest rates continue to be historically high…despite lower Reserve Bank rates, credit card and personal loan rates were lower just over 2 years ago and were never higher from the start of the chart in 1997!!! No wonder the rich get richer and the poor get poorer.
