Are you a glass half empty investor? Or a glass half full investor?
Investors open the week caught between two forces pulling them in opposite directions. Inflation is afoot globally. Higher commodity prices have been good for resource producer so far. But now everyone is worried that high raw materials prices will slow down industrial production. The world will pat its collective belly and say, “Sorry Australia, I’m full.”
You also have the added worry of a lousy financial year for superannuation investors. That is, balanced funds with your basic exposure to Australian and global equities will have had a lousy year. You can blame the All Ordinaries for this. It’s set to finish the financial year down around 17%. That would be its worst showing in nearly 30 years.
The financial year performance is what matters to super investors. But it doesn’t really tell you the whole story, does it? Since June 30th, 2003, the ASX/200 is up 72%. That includes the 23% fall we’ve had from the early November high of 6,828.
It all depends on how you define your terms, doesn’t it? A term, according the Latin definition, is a boundary or limit. But there are all sorts of terms. If you started investing in November of 2007, your time in the share market feels like a prison term. If you’re a U.S. homeowner who bought a house in the first quarter of 2007, it feels like a life sentence.
In the long-term, the conventional wisdom goes, you won’t do poorly investing in the broad market. You should ignore short-term volatility and focus on the long-term real returns above the rate of inflation, which you hope will be between 7-10%. And you know, if you look at a few charts, this long-term perspective is encouraging.
The RBA’s latest chart pack has three interesting charts. First there’s this little gem. It shows us that Australian stocks have clobbered the S&P 500 since the resource boom began. It also shows that while there could be more losses ahead, the long-term trend is still pretty bullish.
Then there’s this little beauty. It’s an even longer-term chart. It compares the ASX/200 to the S&P 500 going back to 1994. There’s at least one bubble visible in this chart, and perhaps two, depending on how you view these things. The first is the S&P’s boom that ended in 2000. The index did make a new high in October of last year at 1,565. But where will it go from here? An answer in a moment.
This last chart shows the leadership of the local market. Financials (the big four banks) have been the slow and steady winners for years. But the resource hare is lately clobbering the financial tortoise. Are banks a buy at these depressed levels? Are resources a sell?
You probably can guess what we are going to say. We say it nearly every day anyway. But we will clarify it again as we begin a new financial year. The world’s financial system is full of an awful lot of rot. Slowly, reluctantly, but irresistibly, banks and brokers are being forced by shareholders and international capital rules to reduce exposure to risky assets.
Practically, this means financials will spend the rest of this year slimming down the balance sheet, selling assets and trying to stockpile cash. But just what assets will the hedge funds and Wall Street banks be selling? And who will they be selling to?
The first casualties of deleveraging will continue to be financial stocks themselves. These companies have massively bloated balance sheets with huge amounts of leverage. The big equity indexes were overweight financials and underweight energy for years. That’s reversing. Eventually, they’ll be overweight energy and underweight financials. But that is a few years off.
In the meantime, emerging markets had better watch out too. Brazil, Russia, India, China..the BRICs…will probably weather the storm. Each has something attractive about it that foreign capital will be reluctant to ignore. But the Pakistans, Vietnams, and Mexicos of the world had better watch out.
Is Australia an emerging market? Nope. But it depends on how you define your terms. Australia is thought of as a ‘risky’ market by some investors who see commodities as a speculation against a weaker U.S. dollar. If those investors see a greenback really in the second half of this year, they’ll sell commodities and buy the U.S. (as insane as that sounds.)
What does Australia have going for it? Well, for one thing, there is the cash rate of 7.25%. As painful as this is for individual Aussies, it’s a huge draw for foreign investors. The Reserve Bank will surely not cut rates when it meets in Sydney tomorrow. It should also give us a clue about the direction of rates for the rest of the year.
The Aussie economy looks strong. But you can tell that people are getting nervous. That’s the trouble with inflation. It destabilizes people psychologically and economically. There’s a lot of data due out this week that will show us what people are actually doing.
On Wednesday the retail trade figures come out as well as building approvals. We’ll also find out what demand for credit is like. Thos things will probably tell us what we already know. The economy is roaring along in some respects, and looking a little tired in others. That’s better than a lot of other places in the world.
The trouble with the long term is that it’s getting shorter and shorter every year. In the age of the 24/7 media cycle, with the Internet and mobile Internet, people receive and attempt to process information faster than ever. There are tens of thousands of variables, and investors somehow try to figure out what it all means on the fly.
But most of what flies over the newswires everyday is irrelevant garbage. You can try and trade it. But it is doubtful that much of what passes for news will actually affect your long-term investment strategy (if you have one.) The interconnectivity of markets makes them more volatile. But it doesn’t mean you shouldn’t think about long-term trends.
In the long term, as Keynes said, we are all dead. But in the short term, we expect to see the indexes lower but the resource shares generally higher. Gold and precious metals are due to take the baton of leadership within the commodities market. We are avoiding the still-bloated corpses of the financial stocks, which will not survive the coming revaluation in their current incarnation. Geopolitically? More on that tomorrow.
The Daily Reckoning Australia