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By Robin Bowerman
Smart Investing
23rd January 2008
Principal & Head of Retail, Vanguard Investments Australia


The falls across global stockmarkets means investors are dealing with a barrage of financial data and emotional messages the likes of which we have not seen for more than a decade.

For some investors (and their financial advisers) this may be the first bear market they have had to deal with. The reality and the power of the emotional influences will naturally tend to override more rational responses which generally appear much later and only with the benefit of hindsight.

Context is important here. Focussing on one day's 7% decline on the Australian market inevitably focuses in on the bad news side of the equation - and immediately raises the question how much further could it fall?

So how you frame your view of the situation can fundamentally affect your reaction to market movements and potentially any decisions you may make. The discipline of doing nothing can seem courageous at times like these.

Vanguard has looked at market downturns in the Australian and international markets since 1980 using month end values to give investors a wider perspective. Past performance is certainly no guarantee of what will happen in the future but it can be a source of comfort knowing that we have been in these situations before and the expectation that this too will pass is reasonable.

For Australian shares as measured by the S&P/ASX 300 accumulation index there have been seven market downturns above 10% since 1980. The average decline in market value was 21.3% and that took place over an average of eight months. That was followed by a recovery period that took 16 months although that average is affected by the time it took to recover from the October 1987 market crash which was 63 long months. If you exclude that single period then the average recovery time halves to eight months.

For international shares (measured by the MSCI World ex Australia Index in $A) there have been six falls of more than 10% with an average decline of 22.1% over 13 months. Average recovery period was 17 months, although it is still recovering from the 2003 downturn.

Looking at the US market in US dollar terms, where most of the concern is at the moment, there have been five declines with the average fall in value of 24.2% and a recovery time of 15 months.

The particular sector that led the way down in Australia was the property sector and it has only had two declines of more than 10% in the past 27 years - including recent events in December. This just underscores what an extraordinary run investors have had in property trusts over the past 27 years.

Now any fall of 20% plus hurts and if you could avoid it you would. But the reality is that these events are extremely hard to forecast - and the impact on professional fund manager portfolios and large superannuation funds underscores that.

At Vanguard we are passionate about the need for a long-term perspective as investors. It allows you to filter out the market noise and focus on getting your share of the economic growth that investment markets give you access to.

A key tenet of the index approach to investing is diversification. It doesn't guarantee you will not lose money but it does spread your risk across asset classes. Our approach also suggests the folly of trying to "time" markets. It is notoriously hard to consistently get those decisions correct. And just as no-one rings a bell when markets peaks no-one sounds a horn when the bottom has been reached so market timing requires getting two difficult judgments right.

Another perspective is to look at valuation signals. We all love shopping for discounts and one fundamental value measure of the stockmarket is the price/earnings ratio. At the end of last year the Australian market was trading on a price/earnings multiple of 15.5 in line with the average for the past decade. At the close of trading on Tuesday (January 22) it was 12.5.

So the value of taking a long-term perspective is to be able to see a buying opportunity where others are fearful and at risk of letting emotion drive decisions.

In times of market turmoil the logic of buying may resonate but then the question turns to what do you buy? Again buying the market rather than trying to pick winners is inherently less risky simply because we do not know where the next market driver - be it up or down - will come from.

One of the classic investment textbooks was The Intelligent Investor written in 1949 by Benjamin Graham. Graham - a mentor to Warren Buffett - once said that in the short-term the stockmarket is a voting machine. In the long-run it is a weighing machine.

 

 

 

 



23rd-January-2008

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