Quick. Don’t think. Just answer. What’s the worst performing month for stocks since 1929?
You’d say October, wouldn’t you? That’s when the big 1929 crash happened. But it’s wrong! September is actually the worst performing month, at least for US stocks. That means if you panic now, you can avoid the panic selling later.
I jest. You should never sell in a panic. But you should know that Australia’s stock market tends to follow the US market. It’s what happened Friday after US stocks fell the night before. Now it gets interesting.
Once all those US traders come back from their extended summer vacations, what do you think they’ll do? They’ll take a look at valuations, economic data, and GDP figures, and they’ll pretend to think. Then, they’ll do what human beings always do: react emotionally and justify their decisions with facts and figures.
But be calm, dear reader. The ‘retirement whisperer’ has things under control. I’m not referring to myself. I’m referring to AMP’s chief economist Shane Oliver. He wrote the following at the close of last week: ‘The absence of investor -euphoria, reasonable valuations, continuing easy global monetary conditions and the improving economic outlook are not consistent with the start of a major bear market.’
What is consistent with the start of a major bear market? How about the complete absence of fear! When I go to the footy and the umpire makes a bad call, or fails to make a call, I have a mate who shouts, ‘What game are you watching, umpire?’ I would shout the same to anyone who doesn’t see the possibility of a bear market from here: What market are you watching, economist?
But maybe it’s not a case of two people looking at the same set of facts and reaching a different conclusion. Maybe it’s the case of two people who have two different best interests looking at the same set of facts and acting in their own best interest. Hmm. Let’s pursue this thought.
For bank economists, the best thing for you to do is stay in the market no matter what. That means the bank’s wealth management firm keeps earning fees on your money. The standard sales pitch for the do-nothing-and-don’t-worry-your-pretty-little-head-over-the-bear line of thinking is that it’s not market timing that matters; it’s ‘time in the market’.
In other words, don’t try to sell high and buy low (like Warren Buffet). ‘Buy, hold, forget, and pay us to do your thinking for you’. That’s the pitch from the funds management industry, a big portion of which the major banks own. But are they right?
Well, it IS true that most investors who try to time the market get it wrong. When reacting emotionally, individual investors tend to buy high and sell low. But this is not because they are bad people.
It’s because they cease to behave like rational individuals. They follow crowd logic. But there is no such thing as crowd ‘logic’. There is crowd behaviour. You see the worst of it at market bottoms and market tops. Crowds are collective animals with reptilian brains.
Not only can you time the market, you have to. That is, you buy shares to generate income and increase your wealth for retirement. If you can’t live off the income, you have to sell the assets. Nobody in the $1.7 trillion superannuation industry wants Australian Baby Boomers to sell. That would be the end of the great super gravy train for super managers, trustees, and directors.
But what’s best for the industry may not be best for you. And in any case, what’s always best for any human being, anywhere, all the time, is to think for yourself. For example, take a look at the chart below and study it closely. What do you see?
I see a popular proxy for junk bonds breaking down on a technical basis. The SPDR Barclay’s High Yield Bond ETF (NYSE:JNK) is a clear example of how low interest rates are like tequila. They make you feel really good about taking really bad risks. The breakdown of JNK should be a signal to you that the thrill-seeking behaviour of drunk investors could crash with reality quickly — the way a face crashes into a glass coffee table after a clumsy fall.
There are plenty of other signs that the bear lurks, based on valuations, sovereign bond credit spreads, and underlying economic numbers. But the surest sign of a market that’s due for a reckoning is the utter complacency investors exhibit in the face of obvious risk. Then again, drunks are not renowned for situational awareness.
Greg mentioned it last week. But I might as well let the cat out of the bag. Based on some of the above analysis (and a lot more), I told readers of my newsletter to sell nearly half of our open positions (locking in potential gains on six of the nine). Even though Australian stocks are still 20% below their GFC highs (while US stocks are 20% above their GFC highs), I published the following:
Source: The Denning Report
Long-time readers will know I’m seldom so direct with a headline. But I didn’t want anyone to miss the point. And this gets back to your interests versus the industry’s. In publishing a ‘sell’ recommendation like that, I exercised one of the great liberties of financial publishing independence. If I were beholden to advertisers, management fees, or underwriting fees from corporate clients — instead of to my readers and the subscription fees they pay — it would be difficult to publish a headline like that.
Of course, not everyone here at Port Phillip Publishing shares my view. In fact, our latest advisory service — the Albert Park Investors Guild — is based on not having a view at all! The publication’s investment director, Meagan Evans, says it’s not necessary to have a ‘big picture’ view on everything. In fact, it causes more trouble than it’s worth for individual investors, according to Meagan.
It’s a practical approach that might be more suited to you if you’re a reader who likes your investment advice without orthodox libertarian anarchism. Take the issue of imputed dividends and international shares. That is a practical issue more than a philosophical one (though it’s not un-philosophical either).
There is disagreement within the financial community over whether Australia’s dividend imputation system should be scrapped, according to an article in today’s Australian Financial Review. Critics say that it creates a bias for self-managed Super investors to own Australian shares that pay income. The article repeats the claim that the system ‘costs’ the federal government an extra $20 billion a year in revenue and has created an under-developed corporate bond market.
There’s no doubt individual investors love franking credits. The Australian Banker’s Association says that Australia’s eight largest banks have paid out $88 billion in dividends over the last five years, with $21.2 billion alone paid out in 2013. If you own shares in a bank, you have equity. Equity holders are entitled to a share of the company’s profits. Why should they pay tax on those earnings twice — once via the corporate tax and once via a tax on distributions? This IS philosophical after all!
Under the current regime, you get a credit for taxes already paid on corporate earnings. To use one of Australia’s most cherished words, that seems ‘fair’. I suspect the real reason the Murray inquiry has floated a change to the system is that there’s a lot of money on offer for a federal government running a deficit. If you’re going to rob people, you might as well rob the ones with the money.
That’s not to say there isn’t a legitimate investment issue with over-investing in dividend-paying shares. There are two, in fact. First, dividends have accounted for about half of the total return on shares as an asset class. The Aussie market is full of growth and ‘risk’ stocks. But when people talk about stocks beating bonds over time, they should point out that it’s not possible without reinvested dividends. If dividends aren’t sustainable through organically generated cash flow (not borrowing), then not only will dividend payouts fall, so will total returns in equities as an asset class.
Second, in their hunt for full or partially franked dividends, Aussie investors may be inadvertently exposing themselves to too much risk in one sector (banks) of one market (Australian stocks) with all its assets concentrated in one basket (residential housing).
This is why Meagan has taken up the task of introducing more international companies in your portfolio. It makes for much more ‘balance’ (rather than what passes for balance today). And you get exposure to sectors you can’t get in a market dominated by banks and miners. It’s a little bit of country diversification.
Tomorrow, I’ll look at whether you can get this diversification from listed investment companies (LICs). I’ll also look at whether you, as an individual investor, can construct your own passively managed index fund using a so-called ‘smart-beta’ strategy.
For The Daily Reckoning Australia