November 2014 Review & Comments
Written by Tony Gray   
Saturday, 13 December 2014 13:37

International & Local Share Markets

In the US the broad share market Standard & Poors 500 (S&P500) index is trading on a price-earnings  (p-e) multiple of 22.5 times.  To explain, it would take 22.5 years of current market earnings to total the market value.  Historically this is a very high valuation.  The average p-e multiple is around 16 times – requiring a 29% fall from current levels.

If we consider another period of high volatility and uncertainty – the 1970’s – it provides some context for my concerns.  At the start of the 1970’s the S&P500 index was trading at around 22 times (i.e. p-e multiple of 22).  By the end of the decade the market was trading at only 8 times earnings!

It’s not all bad news though – share prices did manage some significant rises in the latter half of that decade due to rising earnings.  In that sense the sharemarket did its job as a hedge against inflation.

By comparison, real bond yields were negative for much of the 1970’s (that is, interest rates were below the rate of inflation) – which is the case today for a US bond investor.

I have focused on the US market as most developed markets (rightly or wrongly) take their lead from that market.  If we see falls in the US, then Australian shares will also fall.  Similarly, rising bond yields in the US will result in higher bond yields in Australia – regardless of what the Reserve Bank might attempt to control through use of the overnight cash rate.

On the one hand I am highlighting some reasons for caution, and on the other explaining that we are in an environment where it is necessary to retain growth oriented investments due to the very low or negative real (after inflation) interest rates on offer.  We don’t know if the local market and US market will trend higher, stagnate, or fall in the short-term – but my feeling is that the return potential is lower and the risk level higher.  This is guiding our advice when considering where each portfolio sits within the asset ranges of your investment strategy.

It’s not all doom and gloom.  Since the October letter and my mid-October email broadcast, contrasting the behaviour of the mainland Chinese sharemarket (Shanghai Composite) with the US sharemarket, there has been a further appreciation in China.  There were several days in October, when all other markets were falling, with only Shanghai rising.  So far this month the Shanghai market has continued to outperform other international markets - it does indeed seem this market is marching to its own beat.

We are actively adjusting international portfolio exposures away from the US and towards Asia, including China.  This means an exposure very different to the world index (where around half of your international exposure would be in the US and then most of the rest in Europe).  Whilst we will not always get these active decisions right, on balance they have added significantly to portfolio returns over the years.

AMP Capital China Growth (AGF) – if we have not considered this asset for your portfolio, then please make contact.

Commodity Markets & Australian Shares

A disconnect between sharemarkets and commodity markets is apparent.  The former appear to be pricing in stronger economic and profit growth, whereas low interest rates and falls across virtually all commodities (iron ore, coal, base metals, gold, oil, agricultural commodities) suggest the opposite!

Rather than assume commodities will bounce, the safer option is to adopt a cautious stance and wait if broad share market opportunities present.  I do not see the large price falls in the mining, energy and related engineering and service sectors as an opportunity at this time – the cycle tends to run for an extended period.

As with our approach to international markets, the same active position stands even more so for the Australian sharemarket.  Our market is dominated by very large mining and energy stocks and the banking sector – plus Woolworths, Wesfarmers, Telstra and CSL.  By holding little or no exposure to the weak mining, energy and especially related service industries, we have avoided the very significant falls of recent years.  Instead we have been introducing a range of generally smaller industrial companies across a range of industries and in many cases with international earnings.

We are in the midst of Annual General Meeting season and there are quite a number of stocks of interest.  Many are strong businesses, but priced a little too highly for our liking – the point is we have a shopping list and we’re waiting for some specials.

As always, please contact me with any questions about your portfolio or planning queries.

Best wishes


A.W. (Tony) Gray BCom, LLB, Dip FP, GDipAppFin, CFP, FFin

Principal, TG Financial

Please treat the above comments as General Advice or general information, with no action to occur until we have considered with reference to your financial position, needs and goals.

Last Updated on Wednesday, 21 January 2015 11:08

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