The Markets are Still Crazy After All These Years

We are often asked “when will these markets get back to normal”? Or, “when will this craziness end?”

The following article has been re-produced and edited from a publication by Perennial Investment Partners. We believe it assists in putting the current investment experience into perspective.

Australian equities were up over 4% in July 2012 thanks to a big bounce over a few days following on from Mario Draghi’s (President of the European Central Bank) speech on 26th July that included the comments “… the ECB is ready to do whatever it takes to preserve the Euro. And believe me, it will be enough.” Despite this, the outlook still sees markets stuck in defensive mode and tracking sideways with the uncertainty surrounding Europe, US and China still top of mind.

It’s no wonder investors are feeling nervous with so much “craziness” in global financial markets. Consider these examples of “craziness”:

  • Recently, Unilever, a large European food conglomerate, raised $550 million of five year debt at an interest rate of just 0.85% p.a., which is the lowest ever borrowing cost for US corporate debt.
  • US 30 year Treasury Bonds are trading at such a low yield (2.5% p.a. for 30 years) that last week, a very small increase in market yield of 0.13% in one day of trading was enough in terms of capital loss to wipe out the entire year’s interest gain.
  • Swiss (and US and German) Bonds have been paying negative interest rates with, for example a Swiss Government two year note trading at -0.1% back in August last year.
  • Yield differentials are extreme – a 180 day Westpac Term Deposit purchased today will pay 4.75%p.a. interest, which compares to the forecast grossed up dividend yield on Westpac shares of 10.4%p.a. for the financial year ended June 2013. The dividend yield resulting from buying Westpac equity (admittedly, with greater capital risk) is over double the yield available from lending money to Westpac.
  • Even our dollar getting to a high last year of over $1.10 vs. the USD would have been seen as “crazy” a few years ago.

There are many more examples of extreme defensive behaviour; the real question is how long can the “craziness” continue. For the record, apart from the current market, the previous worst four bear markets in history (1929,1973,1980,1987) have taken between three and a half and six and a half years for the market to recover to its previous high.

The following chart might help to put all this into a wider perspective. It shows the rolling five-year returns of the All Ordinaries Index each month all the way back to 1875. The last point on the graph, for instance, shows the annualised return for the five years to 31 July 2012. Importantly, this index excludes dividends so it makes returns look worse than they have been. This is because there is no historical data that included dividends going so far back.

The chart shows just how extreme today’s market is. It also shows how quickly positive five-year returns recover once confidence and optimistic expectations around future global economic growth returns. The last really poor period, even more extreme than today was in the early 1970’s. Like today, this also was a period of negative headlines with a breakdown in the Bretton-Woods currency system, extreme inflation, OPEC oil price shocks and the fall of the Whitlam Government, all of which were the headline equivalents of our sub-prime, Lehmann and Euro headlines. 1973 saw our market (All Ordinaries) down 23%, followed by a further fall of 27% the following year. The market then rose for six consecutive years, starting with a 63% bounce in 1975.

All Ordinaries Index Rolling Five Year Compound Returns % p.a.


Source: ASX, Wren Research, Deutsche Bank.

So can today’s craziness continue? Is this substantially worse than 1973-74? No one really knows the answer and there are good arguments to say that share market returns may remain subdued in the next few years as Governments and individuals deleverage from the great debt binge.

However, the growing middle class in Asia, coupled with the economic reality that equity holders will be rewarded for the risk they take on over the long term tends to suggest that history may indeed be the best guide.

Our View

We believe that, for many investors, there are now better returns available from equities rather than from debt and deposits and, as such, equities deserve an appropriate amount of our investment capital.

Whilst equities continue to be subject to a far greater level of risk (defined in terms of price volatility), nevertheless, for investors who need to receive a reasonable cash return, investing in equities is becoming an increasingly attractive and superior way of gaining the level of income required to meet ongoing lifestyle and other needs.

If we are lucky, capital gain might follow later. If not, the higher income available from shares will, in the meantime, keep at bay the long (investment) “winter”.

Source: Perennial Investment Partners

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