From bleak to black – what’s the timeframe and the pain?
Although it’s early days – and the financial crisis is certainly continuing – encouragingly, some key signposts to global economic-recovery are showing tentative signs of improvement. So with that in mind, is it too early to bargain hunt for investments?
How investments perform this year depends heavily on the length and depth of the current global recession – and a big driver of that length and depth is the global policy response.
While the economic news will probably still worsen, there are signs that the policy responses are helping, giving some confidence that growth will begin to stabilise – or even improve – later this year and through 2010.
Happily, despite the numerous comparisons with the 1930s, Dr Shane Oliver, head of Investment Strategy and the Chief Economist with AMP Capital Investors, says the response globally to current economic woes has been both more positive and far quicker – meaning we’re very unlikely to experience another Great Depression.
Dr Oliver says signs to date point to shares most likely getting back onto a sustainable recovery path this year. But it will ensure a volatile ride for investors in the short term!
What’s happened?
Last year’s financial crisis and ongoing bank problems mean this year’s key problem will be the economic fall out.
The world’s major economies of the US, Europe and Japan are now contracting in a synchronised way. Add the emerging-world’s slump, and this will probably be the worst post-war global recession – including in Australia – as the OECD’s leading indicator plunges at its fastest-ever rate.
What action is being taken?
Thankfully, says Dr Oliver, plenty.
While both the financial crisis and the still-unfolding synchronised world economic slump are unprecedented, so too is the policy response by governments globally.
These policy responses have focused on:
- rapid interest rate reductions (to near zero in the US/Japan, to record lows in the UK, and sharp falls in Australia and other countries)
- fiscal stimuli, such as spending increases and tax cuts (including the record package announced in the US earlier this month
- unprecedented measures to stabilise financial systems (these vary by country but include giving loans to financial institutions, funds for credit markets, buying private sector securities, injecting capital into banks, insuring some banks against additional losses on bad debts, and guarantees over bank borrowing and lending; the US is also reviewing how to remove toxic debt from banks’ balance sheets)
Should market forces run their courses?
Dr Oliver says to go with free-market ideologues that market forces should be left to run their courses – to “cleanse” the system of past excesses – really means “after the good times of the boom, we now all need to suffer!”.
Such pre-WWII economic management resulted in regular wild swings in economic activity and unemployment. It came at a big cost to society, with much pain borne by innocent, ordinary workers, who lost their livelihoods as unemployment rose above 20%, and/or life savings in bank failures.
“As such, a ‘do nothing’ approach is not politically acceptable to most governments.”
Is the response good enough?
“Too slow” and “inconsistent” are criticisms levelled at the US in particular, where interest rates weren’t cut quickly enough in a seemingly slapdash response. However, really, it was a combination of uncertainty about the problem’s size and the Bush Administration’s philosophical bias against intervening in free markets (the Obama Administration has already proven to hold a different view).
But despite those failings, the policy response in the past year has been far more positive than was the case in the early 1930s as the Great Depression unfolded. Which again makes the two situations very different, says Dr Oliver.
He also allays fears that pumping cash into the financial system will just create inflation, saying until demand picks up, there is no reason to worry. “The big concern is more likely to be deflation… [but] the central banks seem well aware of the need to reverse their policy stimulus when that happens.”
Dr Oliver also says fears of boosted inflation and increased bond yields (from an increased bond supply), occur every recession when public sector budgets head into large deficits – such as now – and both fears are misplaced.
“Expanding budget deficits don’t cause inflation or higher bond yields in economic downturns because they are offsetting an increase in private savings. The Japanese experience in the 1990s was a classic example of this: the budget deficit and public debt blew out, but inflation turned into deflation and bond yields fell below 2%.”
Is the global policy response working?
Yes, says Dr Oliver. Today’s situation would likely be far worse were it not for the capital injections into banks, and guarantees over bank borrowing.
Already, there have been fundamental signs of improvement – including in the US, which, he says, “is the key in all this”.
While many other signposts do need to turn positive, the fact some indicators have turned “a bit more positive” is a good sign, and is certainly consistent with expectations for a global economic recovery later this year and/or through 2010.
Is it time to bargain hunt?
So, with all of that in mind, is now the time to bargain hunt for investments?
Prices have fallen substantially across the board. Even high quality companies, with sound foundations and strong futures, have significantly fallen in value, along with weaker companies.
Yes, bear markets offer the opportunity to buy quality assets at highly discounted prices and lock in potentially outstanding returns. But, it’s not easy to choose the right one, and don’t get bedazzled by “bright shiny things” – every investment must still fit your overall strategy (see section below).
Don’t forget either, trying to “time the market” is never a sound idea – even for professionals. However, it does make sense to consider buying when the markets are so low, and here are 4 good reasons why:
1. Prices have fallen too far: the value of Australian shares has nearly halved, yet compared with most economies, Australia is in good shape. Buying quality assets cheaply doesn’t just leave more room for prices to rise, it also reduces risk because there is less room for prices to fall.
2. Still-attractive income returns: fallen share prices mean attractive income from some quality Australian shares. Yields around 7% are a better earn than many high interest cash accounts; plus, there’s potential capital growth. Quality Australian companies may pay fully franked dividends, resulting in more tax-effective income than from cash.
3. Effective help: central banks and governments globally are committed to fixing the crisis. History suggests that once their taken measures gain traction, investment markets respond positively and returns bounce back.
4. Review Price to Earnings (P/E) ratios: the P/E ratio effectively compares the price of a share with the earnings it generates. The higher the ratio, the more you pay for the companies’ earnings (but it can also indicate investors are optimistic about the company’s potential).
The combination of: bargain prices, attractive income returns and government support provide compelling reasons to ignore all the negative noise and buy quality assets.
Finding bargains
Felix Stephen, Senior Investment Strategist at Advance Asset Management, says there are many buying opportunities, but the market will stay volatile, “so you need to be patient and to hold your nerve”.
“In the medium term, Australian insurance, telecoms and healthcare companies should generate steady returns, as should companies that sell consumer necessities.”
He believes banking and financial stocks will lead the Australian share market recovery.
Remember the basics: comfort and timeframe
Even in times of economic certainty, there’s a lot of information and data to consider, which can often make it all a bit confusing. Because of that, buying bargains in uncertain times is plain hard work! You will have to be “brave” with some of your decisions: do the research and accept that market volatility is far from over.
However, the overriding guides in your decision making - as always – are your own risk profile and investment objectives. It’s fine to hunt for bargains, but recognise that your personal factors must be taken into account, otherwise the bargain might not turn out to be so good after all. And with all of that in mind, anyone looking at for a 2-3 year timeframe should find their investments offer a good return.
If you have any questions about your investment portfolio or whether now is good time for you to invest (further) into the stock market, do not hesitate to contact us – even if it’s in between our regular planning meetings.
Sources: “The global economy – bad now, but some positive signs?”, by Dr Shane Oliver , Head of Investment Strategy and Chief Economist, AMP Capital Investors; and “The great bargain hunt”, by Asgard Capital Management Ltd.