It has been very pleasing to see the market recovery over the past 18 months or so and the subsequent easing in negative sentiment from the general media.
It was only a year or so ago that the media focus was very negative, with headlines such as “Fiscal Cliff” and that Greece and Cyprus along with other so called PIGS Nations would bring down the world’s financial markets.
The Pendulum has swung in-so-far as the markets and especially the bank stocks are concerned. While we are happy to enjoy this positive performance we are also cautious
“things are never as bad as they seem, but never as good either”
We thought now would be an appropriate time to provide you with a market update.
The table below shows the ‘value’ of Australian shares against International shares. That is the relative price we pay to buy a share and receive $1 in future earnings. In short our shares have historically been cheaper – that is traded at a discount (below 1) but are now more expensive (above 1) than the average International share.
Historically this is due to the perceived wider opportunity to grow earnings for International companies is larger than the opportunity here. This discount has been removed as we now see the rest of the world as troubled, while we feel fairly comfortable that the Australian economy has avoided the economic troubles of the rest of the world and that our future looks rosier than the rest of the world. Time will tell in this regard, but generally speaking markets revert back to historical averages.
We do not believe that “things are different this time”
If we look more specifically at the banks; then this relatively expensive position is even more pronounced. Now we love the banks as much as the next Aussie Investor – they have served us well for more than 20 years and for most investors the banks don’t owe them anything.
However if we simply look at the current price of banks compared to their International bank peers they begin to look a fair amount overpriced.
The table below shows that we pay nearly 40% more for our banks stocks to receive the same $1 in earnings. Why? This is most likely explained by the recent move from Term Deposits into Bank shares for those that are targeting Dividend income which is higher than Term Deposit Income.
The problem here is; these are two different asset classes with very different risks – investors need to ‘price’ that risk – the Term Deposit provided the lower return for a reason.
A fundamental rule of investing is understanding the trade-off between risk and expected return
“it is not just about return, it is about risk and return”
At the end of the day the share market is simply a way of measuring the success or otherwise of businesses listed on it. In the US their market has surpassed the all-time highs of 2007, while our market requires a further 33% rise to reach our all-time high of 6851 points. It is no accident that companies in the US have grown earnings to above 2007 levels while overall Australian Listed companies have not recovered to earnings levels of 2007, hence our markets relative weaker performance.
This update is not about picking winners and suggesting big changes. It is about ensuring we all understand that with greater return comes greater risk and that Diversification is the best way to spread the risk.
A nice way to think about it is; having an exposure to defensive investments like cash and fixed interest gives us permission tickets to take on some risk. Therefore while the cash is ‘only’ earning 3% it is allowing us to generate returns via the exposure to growth assets. If we think about it this way we are not as concerned that cash in only returning 3% as some of the growth return is because of the cash.
Cash is also about the ‘rainy day’, it is about not having to sell at the wrong time, it is also about topping up when opportunities arise and protecting capital.
We are also not suggesting that we all sell the bank stocks, over the long term they remain solid investments. But we should be comfortable to take profits and rebalance if our exposure becomes too high in any one stock or one sector of the market.
Our view is that we invest for the long term, have strong diversification to spread the risk and buy quality businesses that can grow and provide solid long term income and growth. It is important to accept that over short time frames (less than 2-3 years) we can experience ups and downs that can test every investors resolve.
As I complete this article it is interesting to see the news of Bill Vlahos and that ‘Investors’ have lost up to $500 million is his betting syndicate – that was perhaps a Ponzi Scheme and nothing more? This horrible situation is probably the best demonstration of the trade-off between risk and reward there could be.
We find it amazing that after everything that has happened over the past 6 or 7 years that there are still mum and dad investors who continue to be wooed by the promise of easy money.
If it sounds too good to be true it probably is
GPL (Melbourne) Pty Ltd