Financial market cycles and “moods”


Financial Planning “This time it is different”…

One of the most famous sayings in financial circles, and the one that we can all laugh at, when we read about economics professors or sharemarket professionals making suggestions such as markets having reached a permanent high plateau – just prior to the onset of the market crash that heralded the Great Depression or the DotCom bust or any one of many such examples.

It seems to me that we are in the same paradigm today, except that it works in reverse…

i’m going to look at some examples of the Australian sharemarket performance these last 5 years.

Please remember the Great Disclaimer – nothing on this site is to be considered personal advice and under no circumstances are you to take action on the basis of this note, as it is general advice only and does not take into account your personal circumstances, objectives or risk tolerance. Also remember that the world is a highly uncertain place, which means that historical data is no guarantee of future performance.

We are told that this GFC (“Global Financial Crisis” for all those who have spent the past 5 years asleep in an enchanted castle) is “different”. We are told that the global financial system is teetering on the brink of insolvency, that sovereign debt is going to swallow the whole world in a sea of IOU’s, that the US dollar is doomed, and we all need to buy gold bars, just to make sure we have something physical to barter with when we go down to the supermarket to trade with the looters.

For those who are not quite so sure about the future, such as myself, we could look to see if things really are that much different this time around? So, we could start this little look by comparing the equivalent performance for Australian shares post the 1987 sharemarket crash. In both cases, we will look at the All Ordinaries Price Index.

Here’s a look at the current play for the global crisis, measured from the sharemarket peak of 1 November 2007. We will look at using the 1987 sharemarket peak as a similar starting point, and track the respective performances.

Financial Planning Perth : Comparing the 1987 sharemarket crash to the 2007 GFC - All Ordinaries Index
It seems we have been here before……..

When looking at this chart, we can make a couple of observations:

  • Although the 1987 sharemarket crash reached a low point very quickly (hence it being called a crash..), its performance by this post-crash point is similar to that of todays market

  • The circumstances of 1987 were vastly different to those of 2007, yet the post-peak performance has been similar in both circumstances.

  • Countries and central banks weren’t in danger of collapse in 1987, yet the performance was similar to that of today.

  • Both large market falls resulted in the unwinding of debt and a reallocation of capital back to profitable businesses with strong business models.

The more things change, the more they stay the same?

That may sound trite but could it be that the folk out there predicting doom and gloom simply don’t have a memory that goes back to 1987? As a hoary old relic of the financial planning industry, i do. i remember 1987 very, very clearly. i remember the feeling of despair as people saw their investments plummet in value so quickly that they could do nothing but look to see what the extent of the damage was. i remember the sense of hopelessness, as people trying to work towards their retirement faced a terrifying future where cash was the only certainty. i remember that everyone was so very certain that markets would never again reach such giddy heights.

And what happened soon after?

Financial Planning Perth : Comparison of the 1987 All Ordinaries post crash performance against the post GFC 2007 falls
The excesses of the past are gradually worked through, and capital is once again allocated more efficiently

You can see that the sharemarket did eventually recover from the 1987 crash. Good companies bought the assets of the companies that failed, efficient business models prospered and when economic conditions improved then the value put on a given dollar of business income increased. It really is a most sensible reallocation of scarce resources.

What is most amazing about post crash times, is the level of despondency that descends on all of those people who have to deal with the consequences of the falls in value. It’s not really so amazing that the despondency is there – it’s the fact that it doesn’t seem to go away. At all. And that just does not make sense.

IF the sharemarket is never going to recover then it’s quite likely that your home, your business, your car and your belongings are going to depreciate in value significantly. The reason for this is that the sharemarket is an integral part of the economy. IF the top 500 companies (which is what the All Ordinaries Index represents) cannot make any money or cannot grow their value THEN there will be a lot of corporate debt that will not be repaid. There will be many employees who will lose their jobs, and cash in the bank will be less secure. This is not to say that Australia cannot descend into a Japanese style deflationary environment – because it can. It’s just a highly unlikely scenario. We won’t go through all the reasons why this may be the case right now but you are welcome to research the Japanese share and property markets, and check for similarities and differences to the Australian markets and economy.

Financial Planning : Let’s not get too positive

i’m not suggesting that the Australian sharemarket is due to rise nor am i saying it is cheap or expensive. i am simply looking at the current commentary – which is predominantly negative, and predicated on the idea that “this time it is different” for one reason or another. Maybe it’s Greece and the Euro issues, maybe its the US debt, maybe it’s the political tensions around the world. All of these points are completely valid. It’s just that these issues are transitory. They are simply the issues we face today, and they will be worked through in the same way that the awful carnage of 1987 was worked through.

i watch the huge CALPERS retirement fund, the Future Fund and many others all make moves to shift their allocation of money out of the sharemarket and into “alternative” investments. There’s nothing inherently wrong with this approach but these alternative investments are generally less liquid and far more expensive to own or operate. Does that make a lot of sense in a capital constrained world?

There are arguments that Australian superannuation funds have too high an allocation to the sharemarket, and we should have more of this and less of that. Some of these people making these comments are promoting their team, so to speak. They represent organisations that offer alternative investments, so there is quite a lot of room for bias. However, even if we put aside bias, we are looking at a market in the throes of recovery – and for long term investors seeking growth assets and an ongoing income, does it make sense to change horses at this stage of the race? Again, i’m not going to bore you (today) with arguments for or against… i’m just going to ask if it is likely that the current circumstances will hold true for the next 5 or 10 or 15 years?

We have now scratched our way through 5 years in which the Australian sharemarket as a whole has not lifted at all. Most super funds have recorded small or nil returns for that period. Is it likely that this will continue for the long term?

What do you think?



Leave a Reply