The financial media are doing their best to hook in readers (so they can sell their advertising space) with a number of doomsday type news items being pushed on to front pages and lead stories.  To be frank, there has been a fair bit of less than positive news out there in the financial world. The question that needs to be asked is whether this time is any different from the past?

Weston Wellington, a Vice President at Dimensional Funds Advisors in the USA has posted commentary on his monthly opinion column that asks this very question.  In response Weston provided a number of media examples which highlight a number of "unprecedented" events which confronted investors in the past:

"On Wall Street, the most unnerving stock market reports since the Depression 1930s became daily more dismal." Time, "The Economy: Crisis of Confidence," June 1, 1970.

"Fed up with rising food prices, thousands of women took to the streets in protest. . . . [President Nixon] announced that ceilings were being imposed on prices of beef, pork and lamb." Time, "Changing Farm Policy to Cut Food Prices," April 9, 1973.

"The only way that the US can scrape through the next several years without major economic and social disruptions is to ease off dramatically on energy consumption." Time, "The Arabs' New Oil Squeeze: Dimouts, Slowdowns, Chills," November 19, 1973.

"There have been multiplying signs that the long American romance with the big car may finally be ending. . . . Economists generally are agreed that the era of readily abundant fuel has ended for good." Time, "The Painful Change to Thinking Small," December 31, 1973.

"Investors have been frightened of an economy that seems out of control. . . . The stock market has scarcely been so shaky since 1929. . . . A Gallup poll published last month found that 46% of adults feared a depression similar to the classic one of the 1930s." Time, "Seeking Relief from a Massive Migraine," September 9, 1974.

"The woes of inflation and stagnation have touched nearly every American, but while some people are only slightly bruised, others feel as if they have gone ten rounds with George Foreman and are down for the count. . . . Pawnbrokers are gaining from once affluent people who have lost their jobs and are trying to get anything that they can out of jewelry or expensive cameras or appliances." Time, "Who Is Hurting and Who Is Not," October 14, 1974.

"Financial markets at home and abroad have been devastated in recent weeks as frantic traders and investors scrambled to come to grips with the anti-inflation policies of the Carter Administration and the Federal Reserve Board. . . . After a nervous September, Wall Street succumbed to despair, and the stock market was bloodied by what is being called the October massacre." John M. Lee, "Tumult in the Markets," New York Times, November 6, 1978.

"Fortunes were conjured out of thin air by fresh-faced traders who created nothing more than paper." Walter Isaacson, "After the Fall," Time, November 2, 1987.

"The next recession won't look like any that has preceded it in recent decades. . . . We are so heavily indebted that a slump would quickly turn into a Latin American-style depression." Ashby Bladen, "Borrowing to the Bitter End," Forbes, September 4, 1989.

"Chase Manhattan, the second largest US bank, is letting go 5,000 employees, or 12% of its work force, in a struggle to remain solvent. . . . The construction industry has creaked to a virtual halt after a decade of overbuilding. . . . From stock markets to supermarkets, high anxiety rules the day. . . . Now the specter of war, rapacious oil prices, and a far-reaching recession haunts political and business leaders everywhere. . . . The banks are basically pushing panic buttons everywhere."

"I want to say we're in a recession, but that's not a strong enough word. In some regions, it's a depression." John Greenwald, "All Shook Up," Time, October 15, 1990. Final quotation attributed to William Hensler, chief executive, Wickes Lumber.

"Imagine every office building in Manhattan empty, a commercial ghost town. Now double it. That's how much vacant office space?500 million square feet?there is in the United States today. Behind much of that empty office space stands the nation's banking system. . . . The worry today is that the real estate recession, which is spreading nationally, could severely weaken the banking system, pulling down many smaller banks and a few big ones as well. . . . 'Our real estate market is as bad as we've had since the 1930s,' said Leo Spang, a Boston banker and president of the Real Estate Finance Association, a trade group." Steve Lohr, "Banking's Real Estate Miseries," New York Times, January 13, 1991.

"Falling real estate prices and the fragile state of the banking system make this recession unlike any other and extremely difficult to forecast." John R. Dorfman, "First Boston's Bear, Carmine Grigoli, Refuses to Stop Growling Despite Stocks' Big Rally," Wall Street Journal, February 7, 1991. Quotation attributed to Carmine Grigoli, chief investment strategist, First Boston Corp.

"The nation's top auditor said today that many more banks were effectively bankrupt than regulators had recognized. . . . 'The bank insurance fund is nearly insolvent, and I cannot overemphasize how important it is to restore it as quickly as possible,' Mr. Bowsher [Comptroller General] told the Senate Banking Committee." Stephen Labaton, "Bank Deposit Fund Nearly Insolvent, US Auditor Says," New York Times, April 27, 1991.

"We're going into one of those long periods where the market does nothing except consolidate this huge move up we've had. Dow 4000 is going to be with us for a long time." Daniel Kadlec, "Will Weary Legs End 20-Year Bull Ride?" USA Today, December 6, 1994. Quotation attributed to Seth Glickenhaus, senior partner, Glickenhaus & Co.

"This economic convulsion is unprecedented in the post-World War II era." Robert J. Samuelson, "A World Meltdown?" Newsweek September 7, 1998

"This time it is different. This time the market won't be so quick to bounce back. . . . Who can look at the world right now and not conclude that things have changed dramatically?" Joseph Nocera, "Requiem for the Bull," Fortune, September 28, 1998.

"Wall Street stocks have plunged?Merrill Lynch down 59%, Morgan Stanley down 59%, and Lehman Brothers down 67%. . . . The real problem is with the risks that are unquantifiable." Bethany McLean, "Can the Brokerage Stocks Come Back?" Fortune, October 26, 1998.

"Investor nervousness pushed stock prices lower yesterday and sent signals of distress through the corporate bond market. . . . Many companies are overloaded with debt at a time of slowing economic growth. Among the stocks leading the decline yesterday were those of companies sensitive to the business cycle. . . . A Morgan Stanley index of 30 of these stocks plunged 4.7 percent yesterday, reflecting the worry that the economy may be headed for another recession." Jonathan Fuerbringer, "Negative News from Some Blue Chips Takes Heavy Toll," New York Times, October 10, 2002. [Note: major US stock market indexes registered multi-year lows on October 9, 2002.]

We are the first to acknowledge that it is not an easy time on markets at the moment.  (what an understatement!) Reading the examples provided above shows us that similar difficulties have been faced in the past.

What transpired after these events?  Markets rebounded, often very quickly.

Now is not a time to sell all your growth assets.  If you had of done so in late October, early November last year you were a genius but doing so now would see you locking in your losses and missing a possible rebound in markets.  This would only serve to further damage your portfolio.  We can not be sure when this rebound will occur but history tells us it will.

Regards,
Scott Keefer

In his latest article written for Alan Kohler's Eureka Report, Scott looks at the performance of the BrisConnections tollway float and how it has destroyed $250 million of investor wealth.

Click on the following link to read Scott's article - The IPO that died of shame.

In his latest article written for Alan Kohler's Eureka Report, Scott looks at whether index funds are suitable investments in a volatile market.

Scott looks at the relatively high proce of index funds in Australia compared to the USA as well as some of the diversification difficulties faced by index funds in a relatively small market like Australia.  However, he also provides evidence that stock pickers do not appear to out-perform in volatile market conditions and concludes that index funds are a relatively low-cost, tax-effective and well-diversified tool within an investment portfolio.

Click on the following link to read Scott's article - What price index funds?.

In his latest article written for Alan Kohler's Eureka Report, Scott looks at the upcoming float of the Brisbane Airport tollway.

Scott looks at how the offer works, that distributions are not related to earnings, the underwriting fees involved with the offer and the performance of a similar offering - the Rivercity Motorway.  He concludes that it is a difficult offering to evaluate.

Click on the following link to read Scott's article - Tollway float not hazard-free.

The latest edition of our fortnightly email newsletter was sent to subscribers on the 15th of July.  This edition looked at whether borrowing to invest is worthy of consideration, provided a summary of the movements in markets over the past fortnight and looked at the failure of forecasts over the past financial year.  If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.

The latest edition also contained the following Market Update:

ASX P/E Ratio and Dividend Yields
From this edition we will be reporting on changes in the Price / Earnings ratio and Dividend Yields as reported by ASX Research.  The P/E ratio is a common broad indicator of the price of shares.  It is a calculation of the price of shares compared to expected earnings.   A higher ratio indicates that share prices are more expensive.  The historical P/E ratio for the ASX has been between 14 & 15.

As of July 8^th the P/E ratio for the S&P/ASX 200 was 10.92.  The dividend yield is 4.73%.

Market Indices

Since our previous edition, Australian and global sharemarkets along with listed property have continued to experience negative movements.  The S&P ASX200 Index has fallen 4.91% from the 27^th of June to the 11^th of July.  It is now down 21.27% from the same time last year and down 21.45% for the calendar year (2008) so far.  The MSCI World - ex Australia, a measure of the global market, has fallen 3.89% over the same period.  The index is down 21.33% from the same time last year and down 17.50% for the calendar year so far.

Emerging markets have also experienced negative movement with the MSCI Emerging Markets Index falling 4.79% since the 27^th of June.  It is down 9.42% from the same time last year and down 17.49% for the calendar year so far.

Property trusts have seen the greatest falls since the 27^th of June with the S&P ASX 200 A-Reit Index falling by 14.31%.  The index is down 46.76% from the same time last year and also down 40.81% for the calendar year so far.  The S&P/Citigroup Global Real Estate Investment Trust (REIT) Index, a measure of the global property market, has fallen 6.33% over the same period.  It is down 27.75% from the same time last year and down 18.10% for the calendar year so far.

Exchange Rates

As of 4pm the 11^th of July, the value of the Australian dollar has been relatively flat against major benchmarks for the fortnight.  It has risen slightly against the US Dollar by 0.02% at .9602.   It is up 11.56% from the same time last year and up 8.92% for the calendar year so far.  Since June 27^th the Aussie has fallen slightly, -0.41%, against the Trade Weighted Index now at 73.1.  This puts it up by 5.71% since the same time last year and up 6.40% for the calendar year so far.  (The Trade Weighted Index measures The Australian dollar against a basket of foreign currencies.)

General News

Since our last edition the Australian Bureau of Statistics has released the latest employment data with the official unemployment rate falling slightly to 4.2% as of the end of June.  The participation rate has risen slightly to 65.3% with employment levels rising by 29,800 jobs.

The Reserve Bank of Australia board also met on the 1^st of July and decided to keep the official interest rate target steady at 7.25%.  The statement published with the decision indicated that the RBA believes that there are tentative signs that inflationary pressures are easing slightly.  Since then, effective mortgage rates have actually risen due to increases passed on by individual banks in the system.

Today I came across a two minute video on You Tube which looked that the question - Can newsletters help you beat the market?  The presenter was Tom Cock who is also involved with the Sound Investing podcasts of which we are big fans.  (This topic is the latest of a series of 15 videos under the banner SoundInvesting on YouTube)

In Australia, these type of newsletters include the Intelligent Investor, Huntleys, Fat Prophet and the Rivkin Report to name a few examples.  They provide recommendations for subscribers as to what individual shares should be bought, held or sold.

In this video Tom looks at American research into whether if you followed the recommendations of investment newsletters you could beat the average market return.  The research was conducted by Hulbert Financial Digest.  (Its main business is producing a newsletter which provides a guide to all the US investment newsletters.)

Hulbert found that since 1980 there has been a high attrition rate amongst these newsletters with 100s going out of business.  Of the ones that had survived, only 4 have managed to beat the average market return.  Interestingly, the conclusion of the report states that most will do better buying and holding an index fund.

On a similar note, an academic study conducted by Graham and Harvey from Duke University in the USA found some uninspiring results for investment newsletters - "Market Timing Ability and Volatility Implied in Investment Newsletters' Asset Allocation Recommendations".  They looked at the advice provided by a sample of 237 over the 1980-1992 period and found that only a small number appeared to have higher average returns than passive portfolios.  They also tested the timing abilities of newsletters by looking at how often newsletters correctly change there asset allocation weights.  Their findings were that the newsletters offered unimpressive advice.

We are not aware of any similar research in the Australian context, but there is a good chance that the same results would be replicated here.

In our opinion you would be much better served putting the subscription fee towards investing more units in a passively invested portfolio based on index funds.

Regards,

Scott Keefer

Last week I wrote a blog identifying some less than impressive stock picking for the 2007-08 financial year.  This week I have come across another example of how stock picking just does not work.

A Daily Telegraph article published December 15^th 2007 provided what they phrased the "hottest" stocks for 2008 according to six leading analysts - Craig James (Commsec), Rick Klusman (Aequs Securities), an analyst from Merrill Lynch, Peter Switzer (Switzer Financial Services), an analyst from Fat Prophets & an analyst from Credit Suisse.  (The hot stocks of 2008)  Each analyst chose between 4 & 5 stocks. 

The returns (including dividends) from the close of trade on the 14^th of December to the close of trade on Friday (11^th July) are set out below.  The ASX200 returned negative -23.29% for the same period (not including dividends).

The performances of these picks are less than appealing with every picker's average performance below the ASX200 index.  The average under performance for all 29 shares was 13.03%.  If you had started with $100,000 you would now be left with $63,685 not including transaction costs.  (Keep in mind that the ASX200 result does not include dividends over the period.  This makes the actual result even worse.)

Now of course it has only been 7 months since the picks were made.  Some of these picks may turn into extremely good investments in the long term.  (Our preferred approach is to buy and hold for the long term.)  However, given the brief given to the pickers to identify the hot stocks for 2008, not the long term, the record speaks for itself.

So what is the alternative to stock picking?

The approach to building investment portfolios taken at A Clear Direction Financial Planning is based on scientific research around the realities of how market works.  We use index funds as the core of the growth component of a portfolio and then tilt portfolios towards the higher risk, higher expected return sectors of equity markets - namely small and value companies as well as emerging markets in the international context.

Take a look at our Building Portfolios and Research based Approach pages on our website for more details.

Regards,

Scott Keefer

In the latest edition of the Sound Investing podcast, published by FundAdvice.com, Paul Merriman, Tom Cock and Don McDonald share their insights into the last six months of poor share market returns, the outlook for the future, the returns from residential property in the US and comment on how to judge the quality of the advice you are being given.

One warning, the radio show is 51 minutes in length and will suck up 23MB of download.

If these constraints are not a problem, I recommend you take a look at the latest podcast - Sound Investing - July 11, 2008

For those who have limited time and/or limited download capability the following is a brief summary of the more relevant material that was covered:

Investment Returns for the last 6 months

Tom Cock provided a run down of the recent market returns with some interesting low-lights for the past 6 months - particularly the Chinese stock market being down 43% and India's SENSEX down 29%.

However, earnings growth is expected to be 8.1% in the US over the 2nd quarter of 2008, up from 7% last year.

The presenters conclude by suggesting that young investors are benefitted by the strong falls in markets as they are temporary set backs and younger investors have the advantage of picking up these cheap stocks - "The Ultimate Sale".

What worked in the first 6 months of 2008?

Investing in commodities was the stand out performer over this period.  For those invested in index funds you were exposed to these gains without having to take a speculative "bet" on commodities.

How to judge the quality of financial advice

The key conclusion from the discussion was not to base your judgment on the current market environment.  Rather, what were advisers recommending in the past and do they have a strong conviction as to what to recommend rather than jumping on to band wagons once the bull has bolted e.g. now recommending that investors buy into energy stocks when they weren't doing this a year or so ago.

Regards,

Scott Keefer