Do the recent huge swings on share markets mean it’s time to sell up and try your luck in property or gold, or will equities settle back into their old habit of producing healthy returns? YMM looks at the reasons for and against holding on to your shares through these tough times.
The report commissioned each year by the ASX and put together by Russell Investments concludes that in the 10, 20 and 25 years to December 2010 (the most recent report available), Australian shares have delivered better returns – from 9% to 11.2%, depending on your personal tax rate – than more conservative asset classes such as cash and fixed income.
The Russell analysis provides strong evidence that markets move in cycles and will continue to do so. Russell concludes that a long-term investment
strategy is preferable and that attempts to time when you enter and leave the market are “fraught with danger” and that investors should look at longer-term historical returns to put the events of the GFC into context. “Although there have been shorter-term periods in history when cash has outperformed shares, over the long run history has shown that share markets have delivered superior returns,” it says.
What will the ASX return per annum over the next decade?
YMM asked expert analysts and asset managers the following question: If equities have historically returned an average of 10% over 20 years or more, can we still expect this level of returns to continue or has there been a fundamental shift in how equities markets work? This is what they said.
• Benny Sada, The Australian Stock Report: 10.5% -15%
“Based on our modelling, we believe the ASX200 will roughly double in the next 10 years to around the 8,000-8,500 point range. This assumes the global uncertainty subsides and the focus shifts back to Australia’s integral role in Asia’s economic expansion. This will equate to an annual market return of approximately 6.75%. If we further assume a dividend yield of 4%, this suggests shareholders can expect to receive an average total return of between 10.5% and 11% a year over the next decade.”
• Dennis Ng, Lincoln Indicators:
“We expect the ASX will continue its long term upward trend over the next 5 to 10 years, led by long term earnings growth particularly from commodity related industries.”
• Paul Zwi, director private clients, myclime.com.au:
“Too early to say. Ask me in 20 years’ time! Although we can’t know this, personally I expect the long-term average returns from equities will get back to the fairly high levels we enjoyed in the past. I’d certainly be very happy with an average of 10% growth per annum plus dividend income from my portfolio.”
• John McBain, CEO Centuria Capital:
“The fact is that the period of relative stability and continuing growth that preceded the GFC is unlikely to return anytime soon and in our view retirement savers who make investment decisions based on that expectation will not be making the best decisions.”
• Shane Oliver, head of investment strategy and chief economist at AMP: 10%
“Over the next five to 10 years we expect the ASX to return around 10%. This is comprised of 4.7% return from dividend income and about 5.3% return from capital growth. This is in line with growth in the underlying Australian economy.”
Quality stocks going cheap
Buying opportunities abound. According to myclime.com.au, these stocks currently represent excellent value. Their recent share price graphs when compared with the myclime evaluation of their intrinsic worth indicate that they’re currently under-priced.
RIO Tinto (RIO)
Recent share price $62.93
Equity per share $38.23
Borrowings per share $13.54
Net return on equity 41.4%
BHP Billiton (BHP)
Recent share price $34.30
Equity per share $10.66
Borrowings per share $2.99
Net return on equity 58.6%
Australia New Zealand Banking Group (ANZ)
Recent share price $21.90
Equity per share $14.09
Borrowings per share $0
Net return on equity 21.7%
GUD Holdings (GUD)
Recent share price $7.40
Equity per share $3.73
Borrowings per share $1.71
Net return on equity 36.6%
Brickworks Ltd (BKW)
Recent share price $10.54
Equity per share $11.36
Borrowings per share $2.02
Net return on equity 6.6%
Some experts point to the fact that the market jumping up and down all the time creates great investment opportunities if you know what to look for.
Paul Zwi, director of private clients for Clime Investment Management, says equities markets are currently throwing up quite a few opportunities, but he does qualify that statement. “We’re still going through the ‘work-out’ phase of the great leveraged debt binge of the pre-2008 decade,” he says.
“What we saw in the US with their sub-prime mortgage debacle, and the sovereign debt imbroglio in the Eurozone at present, is all part of that work-out, and of course it’s not over yet.”
Economic growth, particularly in the developed world where the excessive debt is concentrated, will be held back for some years yet, says Zwi. “Debt will have to be re-paid or written off or inflated away.
Taxes will have to be increased. Banks and other financial institutions will have to be re-capitalised. All those processes take longer than people expect, and will be a drag on growth for years,” he says.
That sounds pretty pessimistic but Zwi also points out the bright side. “Remember, you don’t need to invest in broad economies. You can carefully select individual companies that are doing very well,” he says. “We expect the Australian market to struggle for a while, so a ‘set-and-forget’ strategy will probably not work too well. We have a strategy to use the market volatility to pick up excellent companies at cheap prices, and then trade out of them when they rise beyond their intrinsic value.
Volatility creates opportunities for us to trade around the company’s value as we have analysed it.”
“Also, in Australia we are especially fortunate. We weren’t too caught up in the debt binge, and so do not have excessive borrowings at either the government level or the corporate level.
“We enjoy strong export markets for our goods, and record high terms of trade. We have relatively low unemployment, and a growing population. We have a strong currency, and more or less neutral interest rate settings. We have a strong banking sector and a good regulator. So there are lots of pluses.”
Indeed, if you have a short-term investment timeframe and feel more comfortable being described as a trader than a long-term investor, you won’t have a problem with volatility. It’s your opportunity to exploit large and swift market movements. You may also be trading in currencies and using derivatives like ETFs to ‘hedge’ against certain movements (whether up or down) in the share market generally or a particular sector. If volatility is the ‘new normal’ you’ll be more than happy.
Will things settle down?
“We expect the market to remain quite volatile for the next year or two,” says Zwi.
“It’s hard to be precise with these things. Within the medium term (three to five years), we would anticipate a stronger market.”
Other commentators are not so optimistic. John McBain, CEO of diversified fund manager Centuria Capital, says he expects financial markets to remain highly volatile, at least in the medium term and very possibly beyond it.
“Investors must rethink the conventions of asset allocation,” says McBain. “Conventional ‘time in the market’ wisdom, which holds that taking a long-term position will smooth short-term losses and lead to net investor gains over time, should be viewed with fresh scepticism by many investors in the face of the new reality of market volatility.
“Past performance is an increasingly unreliable guide to future returns,” he says. “The volatility across asset classes exhibited in the years preceding the GFC bore no relation whatever to the extremes in the four years that followed. Volatility levels across all major asset classes in the four years since September 2007 have increased and in some asset classes that increase has been as much as four- or even five-fold compared to the four years prior.
“In the new reality for many risk-averse and even main stream investors, guarding against loss should become equally as important as making gains. Instead of continuing to regard the current environment as the ‘tail end’ of the GFC anomaly, we need to make plans based on the expectation that the conditions of the past six or so months (or longer) are our new reality,” he concludes.
What should you do?
What ‘game plan’ should you adopt if you’re a long-term investor feeling spooked by all that global economic uncertainty we hear about on the news every night, and the fact that the price of your shares and the value of your super seems to be bouncing around all over the place? Here are the YMM experts’ tips:
1. Check how much of your overall wealth you’ve got in each type of asset and what your strategy is (for both your super and non-super investments). If you have too high percentage of your money invested in relatively high-risk “growth” assets like shares or property and not much in low-risk, stable assets like cash or fixed interest, you may need to swap some money around to reduce your overall risk.
2. Retain reasonably high cash levels. That doesn’t mean putting all your money in term deposits. Interest rates are on the way down so you could end up with returns not much better than inflation, and that’s just as risky as market volatility over the long term.
3. Keep some money in shares. It’s time to assess your holdings and decide what’s worth keeping and which stocks you should part company with.
4. Stay away from stocks with excessive debt. Focus on quality if you want to stay in the share market.
5. Look for stocks with sustainable high yields, that have a proven track record of maintaining high yields (dividends) over time (see the investing for dividends story on page 66 of this issue).
6. Look for shares that have high earnings historically and have strong forecasts for future earnings that are sustainable
7. Focus on domestic Australian shares. We have less headwinds to contend with than some international markets at the moment.
8. Look for stocks that provide a sustainable return on equity (ROE). Look at each stock’s historical ROE and forecasts.
9. Read annual reports and seek out stocks with low debt levels and solid balance sheets. If you don’t know how to read a balance sheet, consider doing an ASX course or joining the Australian Shareholders Association.
10. You may have to make a decision between chasing the highest possible returns or opting for lower but less volatile returns. This doesn’t mean abandoning shares and other growth assets altogether. John McBain suggest considering returning to an old-fashioned asset allocation of 33% shares, 33% property and 33% cash.
11. Actively manage your portfolio, including your asset allocation and your shares. The days of ‘set and forget’ may well be over.
Good option: value investing
Clime Investment Management are ‘value’ investors and Paul Zwi says this is an approach that could work for all long-term investors in the current climate. Value investors look for companies that have intrinsic value. They’re profitable, have little debt and great prospects for future earnings.
If you’re looking for value stocks the first step is to look at the profitability of the company. Profitability takes into consideration the amount of capital required to generate that profit. This is known as return on equity (ROE).
“Every business has an intrinsic value derived from its return on equity (profitability) and its inherent business or investment risk. This value may show no resemblance to the current market price because the market is not always efficient or rational. It is a business’s fundamentals and its performance (historical and forecast) that creates the value,” says Zwi.
The second step is to look at the share price relative to its profitability. If a business has solid fundamentals and a low share price, it represents a good buy. At the moment there are companies trading at substantial discounts to their intrinsic value and that represents buying opportunities.
The next thing you need to assess is your return in relation to the risk involved. Shares are high-risk assets so to compensate for that risk you should expect a higher return. In fact, the return should be substantially higher than you would expect from a low-risk asset like a government-guaranteed bank
Zwi’s guidance is to find companies that have sustainably high return on equity, low or no debt, and experienced management, and operate a competitive business model. With all these things in place, your risk will be minimised.
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