After enduring almost two years of relentless declines in asset values, it’s wonderful to finally see some tangible evidence that the world is not about to end.
The Australian sharemarket is up 40 per cent from its March low, the $A has rallied strongly, corporate bond yields have declined sharply, and the listed property market has begun its structural recovery.
The impact of these positive factors on a typical growth investor has been nothing short of remarkable. Returns in our MLC Horizon 5 fund, for example, have improved from -20 per cent over the six months to 31 March 2009, to +11 per cent over the six months to 31 July 2009 (see footnote).
But despite these strong positive impacts, some people remain fearful of dipping their toes in the market again.
Let’s remind ourselves of the drivers of share market returns. Listed share markets are cyclical discounting mechanisms for companies that produce goods or provide services. These companies are, and always will be, real contributors to economic growth.
But in times of extreme uncertainty or euphoria, market participants can drive the price of these companies far away from their underlying value.
When you buy a share, you lend money to the company who then uses it to fund activity. Your return is dividends, driven by company earnings. If the company grows its earnings base and contribution to economic growth, you also receive a capital return as the value of your share increases.
If you can buy this share at a price well below the company’s fundamental value, then the potential capital gain you can make when the market recognises this is even higher!
One upside of the recent downturn is that share valuations are well below the giddy heights reached during 2003-2007. The disciplined long term investor could benefit by buying today.
If the Australian and global economy does move into a classic V-shaped recovery, these benefits will come sooner rather than later. But if the recovery is longer and flatter, these benefits will take more time to be realised.
And remember, dividends paid by most Australian companies have significant tax advantages. Not only are most Australian dividends franked, thereby providing you with a tax credit, but you receive a 50 per cent discount on any capital gains tax payable on shares held for more than one year.
If you want to sensibly diversify by investing globally as well as locally, the 50 per cent discount also applies to global and emerging market shares.
So have we reached the bottom of the current cycle? Probably.
Lagging economic data, such as GDP growth, as well as leading indicators such as business and consumer sentiment, are telling us the rate of economic contraction in the developed world is decreasing. Activity in the emerging world is picking up.
Also, recent company profit announcements in Australia and the US have generally either come in at or above expectations.
The share market itself is also a great indicator of how people feel about the future. Australians in particular are feeling pretty positive, based on the direction of our market since March. Trading volumes have picked up showing more investors are returning to the market.
But I doubt even the biggest bull expects another 40 per cent rally over the next three to six months. Future earnings are unlikely to significantly increase unless consumers and businesses repeat their debt driven spending spree of 2003-2007.
The cost of credit is likely to go up in future not down, and the world is in a de-leveraging not re-leveraging cycle at present.
And the consumer spending stimulus provided by the Rudd government’s fiscal packages has finished.
But for the long term investor, there is less downside risk and more potential upside today than there was two years ago.
Note:Figures based on MLC Super Fundamentals Horizon 5 Growth Fund, net of super tax and fees. This fund is a mix of 85 per cent growth assets such as Australian shares, $A hedged and unhedged global shares, global listed property and global private assets, and 15 per cent defensive assets such as Australian and global government, semi government and corporate bonds, both inflation linked and nominal.
Michelle Heinrich is head of investment specialists for MLC Investment Management
To make a comment on this article, please click below. If you are a registered user of the Professional Planner website, please log in to the website before leaving your comment.
