Is the Australian Stock Market ‘A Class Joint’ For Your Money?

You'd think Australian stock market would be doing rather well with:

• A narrow escape from the Great Recession of 2008
• The resources boom
• Low unemployment
• Government debt to GDP at one third the OECD average
• Four big banks amongst the 25 world safest according to Rabobank
• The world's best treasurer in Wayne Swann, according to Euromoney

But how is the Aussie index ASX200 really holding up?

The charts below compare the performance (by percentage gain) of the ASX200 (in blue) to four of its peers. The American S&P500 (in red), Hong Kong's Hang Seng (green) and the British FTSE (gold). The three charts compare them over 1, 2 and 5 years. The further back you go, the worse the ASX200 appears to do.

Over the last year, only the Chinese have outdone us on the downside. That stands to reason if you see Australia as a safe way for foreigners to invest in China. If China falls, so should we.

Over two years, the story is similar. Except we look just as bad as the Chinese instead of almost as bad. And we almost never managed to post a gain during the whole two years!

It's the five-year chart that should have you on the phone to your stock broker. Or Wayne Swan. Make your displeasure known!

All of a sudden, the Chinese are on top of the pile (but still down over the period). And the ASX200 is the worst performer out of the four indices. Now, admittedly, some of the European exchanges we didn't include in the chart have fared considerably worse. But they have sovereign-debt crises to deal with.

This brings us to today's Daily Reckoning title, brought to you by the movie 'The Sting'. The gist of the movie is that a group of people put together a fake but seemingly credible Tote. That's a place to gamble on horses. Anyway, they convince people it's real by creating fake races. 'This is a class joint' the manager tells his customers. Of course, it helps that staff happen to give gullible gamblers incredibly accurate tips on which horse will win. For a short time, the few real punters at the Tote make money from the tips. They are drawn in, thinking they've discovered a free lunch. Next thing they know, they lose several times more money than they won as every single tip proves wrong.

At least that's how we remember the movie. And after reviewing the charts above, it should sound familiar. You've been told the stock market - and house prices - always go up. But it only takes a market crash to bring reality storming back. Meanwhile, you've been tricked into tying up your capital in someone else's business, at someone else's brokerage, or someone else's fund. All at a cost to you.

Sure, just like at a casino, there are some winners. But are the odds of relying on the capital gains of the broader market in your favour? And even if they are, is it worth the risk?

That's the big problem with relying on capital gains in the stock market. They can disappear when you need them. Which is why Slipstream Trader Murray Dawes reckons his risk-management techniques are the key to his success, not just his ability to spot trades.

'The three things I want to achieve with my trading are lowering the risk on a trade as quickly as possible, continually taking money off the table to ensure my P+L is heading in the right direction and also exposing myself to large upside if a stock continues to trend. My risk management system is the cornerstone to achieving these three things.'

Murray has been suspiciously quiet these last few days. To find out why, you can watch his free video here. But, as his subscribers know, this is the quiet before the storm. Murray has a habit of sending out no new trades for weeks before pouncing on the market with a flurry of carefully considered positions. The whole office tenses up when he goes on a new rampage.

But need it be so? Aren't there investment opportunities that give you a peace of mind instead of something to worry about? We hope to answer that question with a resounding 'yes' in coming months. We'll keep you posted on how.

But why is the ASX200 performing poorly?

So who is to blame for Australia's poor stock market performance?

It's probably the Aussie dollar's fault. It's up significantly across each of the time periods we mentioned above. In other words, gains in the currency have cancelled out moves in stock prices.

This takes a moment to understand. Usually stock markets move in similar ways. So when they diverge, people go looking for a reason. In this case, the strengthening Aussie dollar could explain much of the divergence. Foreign investors in Australia made their gains in the Australian currency instead of the Australian stock market, but the gains were similar to their domestic stock market.

This shows the importance of factoring economics into your investment decisions. In two senses. Firstly, your returns measured in foreign currencies haven't been all that bad. If you've been holidaying overseas or buying Christmas presents online, you'll know that means things are cheaper. But that's small comfort when you look at the returns from your super account.

That brings us to the second sense economics should factor into your investment decisions: you should be prepared for things like currency movements, domestic and foreign recessions, and asset price bubbles. They can make or break your investment returns.

To be mentally prepared, you might want to read something like the Daily Reckoning Australia. But we'll leave a discussion of why to another day.

Instead, how might you be able to make your portfolio benefit from economic trends, events and ideas?

This is where the world of ETFs comes into its own. Exchange Traded Funds are tradeable on a stock exchange, just like stocks. But they represent a holding of assets. Maybe a commodity like gold. Or a currency like the US dollar. Most of the time the price of the ETF simply represents the value of the assets it holds divided by the amount of shares on issue. If a gold ETF holds a billion dollars of gold and has a million shares, the ETF share price will be around $1000.

But some ETFs are a little more sophisticated. For example, this ETF 'aims to track the performance of the price of gold bullion, with a currency hedge against movements in the AUD/USD exchange rate'. In other words, if we understand it correctly, an Aussie gold investor worried about a gain in the Aussie dollar's exchange rate outweighing any gains in gold could have bought this ETF. If the gold price rises in USD terms, the price of the ETF on the ASX will go up about as much, regardless of the Aussie dollar's performance.

That's the theory anyway. BetaShares, which set up the ETF we just described, has a couple of other currency hedged commodity ETFs, including oil and agriculture.

Now we're not sure about these ETFs just yet. In a world of extreme uncertainty, depending on slightly odd and unproven investment mechanisms might not be such a good idea. But ETFs do open up the world of macro investing to the average Joe. Meaning anyone with a brokerage account can easily place bets on economic trends like currencies and commodities.

But back to the underperformance of the ASX200 relative to foreign indices. We suspect the financial world has played a cruel joke on us Australians. You see, a rise in the Aussie dollar has depressed our stock market. (At least, let's assume for a moment that's the case.) Does this mean if the Aussie dollar collapses our market will soar?

Our bet is Aussie investors will be disappointed again in that scenario. You see, the conditions under which the Aussie dollar would collapse aren't exactly bullish for the stock market. Falling resource demand, a China property bubble collapse, an Aussie property bubble collapse... None of these are good for the stock market. But they would send the Aussie dollar falling. Perhaps Aussie stocks might fall less than they would without a currency adjustment. Our exports would do well with a lower dollar, for example. But the damage from falling asset prices would still be frightening.

Perhaps this lose-lose scenario has been keeping foreign investors out of the Aussie market, depressing demand and price. The currency risk and the price risk are both peering over a cliff as far as foreign investors are concerned. And without them, the Aussie market can't be expected to do very well.

ALSO THIS WEEK in The Daily Reckoning...

US Military Power and the "After America" Blowback for Australia
By Dan Denning

The United States government has decided it can no longer afford to fight two land wars at the same time. You may have missed that little news item from last week. And if you didn't miss it, you'd probably agree that for a nation over $15 trillion in debt, it's going to be pretty hard to pay for two big land wars, much less fight them.

How Central Bankers Attempt to "Cure" Insolvency
By Eric Fry

Like trying to patch a nuclear reactor with scotch tape and chewing gum, the central banks of the world's leading economies are trying to Spackle over cracks in the global monetary system with a variety of desperate tactics and measures.

System D is for Free
By Joel Bowman

It's all happening, Fellow Reckoner. Gold, stocks, oil...all have rallied to important highs. That's what the papers say anyway, so it must be true. Gold has "reclaimed the rally," reported one outfit. The Midas Metal was trading for around $1,634 an ounce last we checked, up $24 in as many hours.

Caught In a Greek Debt Trap
By Greg Canavan

All too often in the world of money we think of things in the abstract. Money is after all an abstract concept. But at its core, economics is about human beings going about their daily business. We make choices. And these choices filter through into the financial world.

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