- LEVERAGE 2. LEVERAGE 3. LEVERAGE 4. LEVERAGE 5. HOPE
My ramble on the property market, the banks, APRA, index investing, market timing and diversification.
Ok so you probably gathered I am experimenting with a bit of click bait.
I am also curious to see if all the keyword tags will see increased traffic on the blog. If I see some clicks on this blog (it doesn’t normally get many views!) maybe we do have a serious boom! This may be possibly followed by some hate mail from property investors as I express some caution on prices in Sydney and Melbourne. I firstly admit I have zero credibility as I have underestimated, and not taken full advantage of the property boom we have seen.
As I have recently taken a closer look at some of the older domestic LICs in the market that hug the index to an extent, I was a little surprised the extent of holdings in the major banks. I had a rough figure in my mind what the major banks may make up of the index but it was lower than I realised. From what I understand we are not far of 30% for the four major banks alone, I am not counting other banks and financials here.
I then began to ponder about how in the early 1980s the Australian share market had a huge exposure to the resources sector, which was not where you wanted to be for almost the next couple of decades. Around the peak of the tech bubble News Corp was a huge part of the index, where some fund managers were getting hired or fired based on getting this call correct. The company was bid up so much from funds giving up on picking the direction of News Corp and just following the index. You would just buy it and be market weight and let your other calls decide your fate. I wonder if some of the strength in banks lately is related to this line of thinking.
Another reason for the strength may be the out of RBA cycle rate rises potentially enhancing margins. There is probably some merit to this thinking. I would caution too much excitement though, as the pressure applied from APRA has opened an opportunity for non-bank lenders who don’t face the same scrutiny from the regulator. It may have transferred plenty of customers away from the major banks, and perhaps they will stay away. Then again many get the feeling it has been a bit of a furphy anyway, suggesting that there are ways around the banks to keep growing investor lending above the targets that APRA frowns upon.
My feeling is that the Australian economy may face some pressures building up soon that are not being discussed that widely right now. High property prices in the two major capital cities in my opinion will not boost consumer confidence, but rather do the opposite. Many boomers now see it as a negative on behalf of their kids / grandkids, Gen X see it as a negative if they aspire to upsize and we know what the younger generation think. This is a major shift from when prices rose dramatically circa 1998-2003, it then provided boosts to confidence and spending. I just see it now as a dent to the consumer’s spending power having to take on bigger mortgages. If you subscribe to the theory some of the price pressure is being fed from China after large price rises in their major cities, I’m also uncertain how that translates to improved consumer confidence in Australia. Also, the major banks are raising rates led by pressure from APRA. The pressure from APRA also extends to property developers, meaning the construction sector could be in for a serious slowdown. Despite some predicting a RBA hike this year, I can see a soft construction and retail sector and the RBA can wipe its hands of the property boom issue. They can point to APRA being the best way to target it, and saying it is confined to Melbourne and Sydney. The relief valve for the economy may have to come from a declining AUD.
As I have proved when blogging it can be a mug’s game when trying to capitalize on these macro issues, so why do I bother? The answer in my case is about diversification and minimizing drawdowns, not trying to time the market. I don’t advocate shorting the banks in Australia which has been a widow maker trade for hedge funds in the last decade or more. The point I am trying to make is we can largely stay invested in the market and capture most of its “beta”, without having to be too concentrated on certain themes and going near potential bubbles. There are enough stocks in different markets in the world to avoid areas that you may think potentially show signs of being overheated.
This is a complete harry hindsight comment but I would argue it should have been a relatively easy decision to have not owned Japanese shares in the late 80s, or US “new economy” shares in the late 90s. That didn’t mean you had to time the market. It just meant noting extreme valuations may spell trouble, and to direct your attention to other stock markets or sectors. The old “time in the market” adage does not require you must have all your savings in one market, where an ETF may give you four very similar stocks in the same sector totalling 30% of your investments.
I bring this up as I see a love affair going on with index investing right now. I am a huge believer in passive investing for most people I just believe it should be given a bit more context when it is discussed. I see discussion threads about Australians stretching themselves to get their first home and do the hard yards to free up a bit of equity and establish a line of credit. Then they “diversify” into a different property on the coast or interstate. The next diversification may be some ETFs and old fashioned LICs full of bank stocks. As this works out well why not diversify into some direct bank shares for the yield. As this works well why not diversify into their hybrids. They may come up with the idea on their way to their work, for the bank. Perhaps a slight exaggeration but you get the picture. At the end of the day they probably just want the double-digit growth that the share markets seem to have delivered in the US and Australia the last century.
We only know with hindsight that these were two of the great countries to invest in at the beginning of the 20th century. For someone starting to invest early in their career now, do we really know this continues for the next 50 years? It probably will I hear you say, and I probably agree. I mentioned Japan before as a recent example of a major country having a disastrous experience for investors. Russia and China have been examples I believe where the entire stock markets have amounted to nothing at different points in the last century. Germany is not exactly a small country either where your shares would have been painful to hold during hyperinflation. The huge drawdown in US shares after the Great Depression is also well documented.
A long while back we probably had excuses not to diversify. Which brokers could we use for offshore markets and at what cost? These excuses are clearly lacking now with the internet, global access, and huge ETF market.
Getting back to my points about saying Japan in the late 80s and US tech stocks in the late 90s showed some clear signs of exuberance and worrying valuations, where should we be concerned now? In virtually every valuation method the US share market is looking stretched. As usual, there are excuses why it’s different this time, and many of the excuses I honestly think sometimes sound reasonable. I just feel there are enough warning signs to largely avoid this market. I’m not saying to go 100% cash, but to look elsewhere in the world. In some ways, I am going against Warren Buffett’s recent reiteration of his suggestion for most people to go with a 90/10 approach, being 90% in a passive US equities ETF fund and 10% in bonds. That may get me some more hate mail also. I believe the US market may be hitting 30 on the CAPE ratio. Why not perhaps consider broadening this passive investing approach to Europe, Asia and Emerging markets where the CAPE is maybe half of that. You may be surprised to the extent that valuations can drive future returns rather than your perception about where the economy may head in the future. (Read the link I provide further down if you doubt that). I personally think these currencies also stand a good chance of outperforming the AUD in the future.
I don’t like currency “risk” I hear you say? In 2008, owning some equity exposure outside of Australia didn’t feel as risky when the AUD was collapsing compared to Australian shares.
What other asset classes may be risky, and that we can search elsewhere for our “beta” rather than time the markets? Well readers may well be living in it. My initial headline might have been tongue in cheek, but it is not that far off some of the news stories I have seen from property moguls aged in their 20s of late. It is hard to predict the top and I am not trying to (I’ve tried and failed before like most!). I just believe more Australians would be better served by broadening their horizon when thinking about investment opportunities. Many seem to take the approach it must be to either buy an investment property yes or no, or leverage into bank shares yes or no. When I started to have an interest in shares we paid 2.5% brokerage, maybe even some stamp duty, and had to ring up from the landline. We have far more investing alternatives open to us now but it seems many are stuck in the past with their way of thinking.
Now you may rightly point out what would I know? This is just a ramble with no evidence of support. Well here is a link with some data and pretty coloured numbers. Not my work, it is from Meb Faber who I have recommended his books and podcasts here before. Some of the charts and data towards the end may lead you to think more about where are the cheapest markets in the world today, rather than limiting ourselves to an ASX ETF with a huge exposure to banks or the US market. Here is the link, I think it is a very good read and may challenge a lot of what you have read elsewhere concerning the debate of timing the market or “time in the market.”