It is fair to say that we are living in some very interesting times for markets. The questions you might want answered are; will the markets go lower? And how long will the current conditions last? It is all very well to ask these questions, but we need to look to the past in order to find out what will likely happen in the future. 

After what has felt like a cyclone-driven restructuring of the US / world financial system in recent months, rarely have the prospects for the world economy appeared so uncertain. Whilst there is general agreement on the need for the US and other western economies to reduce debt, there are wide differences of opinion over how rapidly this will occur and whether the immediate threats to confidence in the financial system will degenerate into a collapse or whether a more orderly workout can be engineered. 

Although history indicates that buying low after market falls is a better strategy than buying into the optimism that precedes them, the unresolved aspects of the current crisis argue for a degree of caution. Although we believe that an unduly negative view of the future is priced into financial markets, a period of lower volatility is necessary to allow sentiment to regroup. Investors need to be confident that the process of debt reduction will be more orderly than over the past year, allowing them to pick up the cheese on offer without looking for a mousetrap underneath. 

The Panic of 2008

Over the past year there has been extreme volatility with reactions to breaking news. This extreme volatility has affected other markets also. Who would have believed three months ago, when oil was $147 a barrel, that it would now be less than $50? Or, perhaps most amazingly, that the Australian dollar would have fallen from an over-valued 98 cents to 65 cents? Over the past few months we saw the Australian dollar move by more in a single day than it has at any time in the past 25 years, the period over which we have had a floating currency. 

Given the ongoing high levels of volatility in financial markets difficult credit market conditions and concerns about inflation and economic growth, investors are justifiably nervous. Most fund managers are holding an above average holding of cash and very low equity positions. So what conditions do we want to see, to regain confidence in the AUS stock market?

One of the biggest problems affecting corporate, financial institutions and households is the higher cost of borrowing (larger deposits required and tighter control of lending). Add to this the increased difficulties in obtaining a loan or mortgage since lenders tightened their credit standards, and borrowing has become a very difficult and expensive take. Borrowing rates are high because banks are looking for capital to shore up their balance sheets, with many having revealed large losses, but they fear counterparty risk and are reluctant to lend to each other. To ease this situation, we need to see trust restored between banks when the stream of drab news dries up and there is a clear evidence that the US and UK housing markets have stabilized. Official interest rates also need to fall, to help ease the funding pressures and the weak growth outlook. 

Going Forward

So what should an investor do in this environment? The most important qualities to have are patience, resilience and calm. Equally trying to time markets in these extraordinary times is a fool’s game as the swings on a daily basis mean any entry point will be random; new investments should be phased over a period of time. Moreover, focusing on a the long-term strengths of a fund manager and the environment in which they work rather than their short-term performance will be critical to longer term performance. We believe that is where a qualified professional who is focused on finding the best long-term investment opportunities and who is not fazed by short-term noise/media articles. 

Meanwhile, high levels of inflation, driven in no small part by higher commodity prices, are eroding profit margins and consumer confidence. However, inflation usually recedes in low growth environments due to declining demand, for example the UK second quarter real GDP growth was 0%q/q. If commodity prices continue to fall and inflation expectations decline against a background of excess capacity, this could sow the seeds for significant monetary easing and a stock market recovery in 2009.

Tight credit conditions, high and volatile commodity costs, a cyclical downturn in consumption, falling house prices, rising inflation and bad news flow all continue to pose significant risks to growth and earnings outlooks for the remainder of 2008 and for 2009. However, world equities are at attractive levels on a price to earnings (PE) basis, and once we see these factors improve, underweight investor positions and ongoing merger and acquisition activity may provide extra support once market sentiment finally improves. 

This has led to many investors wondering what they should do. Reduce your current house loan, send money to your superannuation, invest in property overseas or keep the money in the bank. All are good options, however we need to weigh up your circumstances and buy into a diversified portfolio of assets. Below we have given some tips for investing over the coming year and beyond:

1. Take comfort from history – the long-term trend is up
Invest for the long term. Long term investments are setup to account for short term volatility. Over the last twenty years or so, there have been at least ten major events that have had an impact on the world share market, including the famous Wall Street Crash in 1987 and the Tech Wreck of 2000. While each of these events resulted in a sustained period of market downturn, the market has always recovered.
Importantly, despite short-term market uncertainty in the past, over the long-term the general trend of share markets is upward. World shares, for example, continue to perform very well, up 197% in the last ten years. Similarly, world listed property, which fell nearly 38% this year, has returned 128% over the same ten year period.
2. Stick to your original investment plan
Have your goals actually changed? Understand what you’re trying to achieve and how long you’re prepared to invest, rather than focusing on what’s happening in the market. Keep in mind that the longer your investment timeframe, the more likely you’ll experience some form of short-term market volatility.
3. Don’t overreact to short-term market movements
Investment markets move in cycles, so it’s difficult to forecast when they’ll rise or fall. Moving your money in and out of the market during a downturn means you could potentially miss out on any positive bounce gained in a strong market recovery.
This view is supported by history. For instance, research on the Australian market since 1985 shows that the Australian share market returned an average of 28% in the year following a negative return.
4. Diversify your investments to help spread risk
Diversification – or spreading your investment portfolio over a range of asset classes. All of our clients portfolios have been setup to manage a balance of cash, fixed interest shares and property in accordance with their risk profile.
You can diversify your investment across different asset classes, regions and investment managers or styles. We have done this with many of our clients portfolios and many of our clients hold cash in the bank, direct property as well so hence diversification has been achieved.
5. Consolidate your superannuation and ensure you have the right structure
Many Australians I see still have three (or even more) superannuation funds with little idea of what or where it is invested. THIS IS YOUR MONEY and you should know what it is doing. We can consolidate this for you and give you some guidance on what are the best options for this. Many Australians have decided on taking the self managed super option, which is fine, however if the trustees are both out of Australia (i.e. husband and wife) you could be taxed @ 45% for being non compliant. This is easily resolved and we can help you work through this. 

Final Note

These are interesting times to invest and by continuing to invest in your plans and goals this short term downturn will benefit your portfolio’s growth. I believe that the actions of central banks will help restore stability to stock markets, in the long term, and I remain optimistic about the long-term prospects for equity investing. 

The places/industries that we have your money invested in will still continue to grow as the markets will return to a state of normality. Companies will still make profits, business will still grow and the money markets will have the liquidity they require to lend businesses/ individuals.  

These recent market movements have made a lot of the company’s shares good value to buy (Microsoft bought back shares recently), the fund managers will look for these opportunities with the cash they have in the pool. In addition to this now is not a great time to sell and move to cash, like the property markets in the UK, Dubai and Australia would you sell this asset now or hold onto it?

Looking back on 2008 it is fair to say we can all take lessons from what has happened and perhaps look at what is going on right now as a positive correction which we will all benefit from in the future.

cholding@acuma.ae