We finish another week with the All Ords flirting with the psychological 5000 point level.
A ‘buy the dip’ mentality is keeping the market afloat.
When confidence turns to doubt, ‘buy the dip’ will be replaced by ‘let it slip’. We are not there yet, but it is coming.
The news that debt-laden steelmaker Arrium Ltd [ASX:ARI] has been placed in administration is another sign of the credit stresses within the system. Too much debt, and not enough revenue.
Arrium is not the first to feel the pressure, and I can assure you they will not be the last.
Far too many companies bought into the false narrative that a recovery from a debt crisis could be solved by more debt.
The sham recovery is being exposed by the Arrium-like failures.
This week, IMF chief socialist Christine Lagarde warned about the social and political dangers of a low growth global economy.
And just how are you going to fix that Christine? More debt. Brilliant.
The powers-that-be are the problem, not the solution. They’re only going to make matters worse, not better.
Now more than ever, you need to take personal control of your financial position.
The share market may have been the investor’s friend in recent decades, but it’s on the cusp of revealing the other side of its split personality.
Things are going to get ugly…for longer than most think is possible.
With this in mind, over the next few Markets and Money articles, I would like to share with you what I’ve learnt from 30 years in the investment business.
Hopefully this information assists you in making better decisions on how to best manage your financial affairs in the challenging times we face.
Lessons learnt from 30 years in financial planning
The past three decades have been an exciting time to be involved in investment markets.
From its humble beginnings in the early 1980s, the investment industry has evolved into a multi-billion dollar industry.
This phenomenal growth has not been without its fair share of heartache and setbacks. Each market downturn and product failure provided valuable learning experiences.
There have been many drivers contributing to the industry growth — compulsory superannuation, massive credit expansion, baby boomers moving towards retirement — but, in my mind, the industry’s success during this time was largely underwritten by the share market’s 1,500% increase in value…from 400 points in 1982, to nearly 7000 points in late 2007.
This history-making performance supported the industry’s narrative of: ‘in the long run shares always go up’. Investors and industry players had little reason to doubt the legitimacy of this storyline.
While the market went from high to high, interest rates were falling from 18% to 2%. Without these dynamics at play, it’s my contention the investment industry would not have prospered to the extent it has.
The bursting of the credit bubble in 2008 has given rise to a new set of dynamics. Ones that I suspect — in time — will alter the bullish perception created by the past three decades.
The global economy is undergoing structural change — it’s no longer being infused with massive doses of private credit. The air is escaping from the bubble economy.
Based on the established principle of ‘for every action there is a reaction’, the next decade or two is unlikely to be as friendly for share investors. The tailwind of credit injection now becomes the headwind of credit rejection.
So, after 30 years in the investment industry, what have I learnt to prepare me for the difficult market conditions that appear destined to confront us?
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Being respectful is an important quality in life. Pride and arrogance often lead to spectacular falls — as demonstrated by the long list of failed entrepreneurs.
The world’s central bankers would do well to exercise a little humility. The hubris on display from the world’s central bankers has been particularly galling. Consider this extract from the CBS 60 Minutes interview with Ben Bernanke (5 December 2010).
60 MINUTES: ‘Can you act quickly enough to prevent inflation from getting out of control?’
BERNANKE: ‘We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.’
60 MINUTES: ‘You have what degree of confidence in your ability to control this?’
BERNANKE: ‘One hundred percent.’
100% confidence in his ability to control the economy — what conceit… This is the same Ben Bernanke who told us in March 2007:
‘the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.’
And two months before Fannie Mae and Freddie Mac collapsed and were nationalised, Bernanke said: ‘They will make it through the storm.’
I lack the academic pedigree of Bernanke, but the school of hard knocks has taught me to respect markets. My cautious outlook and simple approach on portfolio construction is borne from being taught very painful lessons by markets.
Bernanke’s successor, Janet Yellen, is learning she cannot control markets either. However, the only damage the Fed chiefs incur is reputational — whereas for investors who believe in the Fed’s self-professed superpowers, it’ll be financial.
There are no new ways to go broke — it is always too much debt
‘Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.’
On Credit Cycles and the Origin of Commercial Panics, 1867
147 years ago, John Mills recognised the folly of man, money and mania. Nothing has changed. Debt is the common denominator in all financial disasters. Those who live by the creed ‘you have to bet big to get big’ can be lucky, but they are in the minority. The majority end up wrecked on the rocks of financial reality.
Hyman Minsky said ‘stability breeds instability.’ The longer a trend is established, the greater the certainty in the investors’ minds it will continue.
The following spreadsheet from the Reserve Bank of Australia (RBA) website shows the volume of margin lending from June 1999 to March 2009.
In June 1999, total margin lending stood at $4.713 billion. Fast-forward to December 2007 (the peak of the Australian share market) and total margin lending had increased to a mammoth $41.589 billion — a near nine-fold increase during the decade. As a point of note: as at December 2015 the figure had fallen to $12.1 billion.
The quarterly data provides a fascinating insight into the greed mentality that gripped investors during the 2003–07 bull market. Four straight years of 20%-plus returns per annum bred complacency.
Source: Reserve Bank of Australia
The Storm Financial debacle should be a warning on how badly this margin lending exercise ended.
The creed ‘slow and steady wins the race’ should be remembered by all those considering chasing the quick buck.
The best luck is bad luck
Success without bad luck is a disaster waiting to happen. Bad luck and misfortune teach you to appreciate the good times. Success without setbacks is conditioning you for a Minsky moment — your continual success will inevitably breed your failure.
You are not an investor unless you’ve lost money — the trick is to not lose too much. These ‘ouch’ moments (should) teach you the respect I mentioned above — sometimes we (mainly males) need more than one lesson.
Don’t beat yourself up over your losses — look at them as ‘school fees’.
If I look back at my ‘bad luck’ experiences, they usually resulted from not really understanding the risks embedded in the investment, acting on impulse and/or greed.
Thanks to the lessons learnt, these days my approach to investing is much more disciplined… and simple. If I do not understand the investment, I do not proceed.
Patience truly is a virtue. In this fast paced world, instant gratification has become the norm in our society. The thought of taking 20 years to pay off a home, or 40 years to build retirement capital, is completely at odds with the ‘want it now’ attitude.
‘Buy in haste and repent in leisure’ is so true. Exercise patience when considering investing — rarely are ‘once in a lifetime’ opportunities the shortcut to riches you thought they would be. Whenever I hear ‘once in a lifetime opportunity’ my retort is ‘so never again in my life will there be another opportunity to profit?’
You’ll also need patience after you’ve invested. Markets do not always behave the way you want them to; nor do they act within the timeframe you’d prefer.
My strategy at present is to be 100% invested in cash and term deposits. Fortunately, in Australia, we can still access rates around 3% — however our rates are under pressure from the ‘Great Credit Contraction’ gripping the global economy. My strategy has factored in rates being below 2% in the next 12–24 months.
Waiting patiently in cash is not easy when share markets still appear to be a viable investment alternative. It is far easier to be patient when markets are falling.
Naturally, I’d like to see markets fall further and more quickly to mobilise the cash holding. However, you have to recognise markets will express themselves in their own time — irrespective of your desires.
The problem confronting the majority of self-funded retirees who want to adopt a cautious investment approach, i.e. cash and term deposits, is ‘how to fund their living expenses’.
The investment industry’s solution is to recommend high-yielding shares, REITs and/or hybrids.
My question is ‘at what cost does the extra few percent come with?’ If share markets fall 50%-plus in value, was the reach for extra yield worth it?
Waiting patiently in cash may mean using some of your capital to subsidise living expenses. So be it. However, when markets do correct (and they will) you’ll be in a position to deploy your cash to buy assets at significantly discounted levels.
Look for Part 2 in next Wednesday’s Markets and Money.
Editor, Markets and Money