It seems investors are heading for the exit door, again

Whilst sipping your morning coffee over your preferred news service in recent days, you may have encountered some uncomfortable headlines that implied that it seems investors are heading for the exit door, again.  As is often the case when there is a slight correction in the share market, the headline writers of our major newspapers crank up the “doom and gloom” machine:

Investors are heading for the exit door, again.

“Slump”, “decline” and worst of all “crash” are often adjectives used to describe the state of a falling share market, as though numbers on a screen have a physical presence about them. Against this backdrop, it’s sometimes easy to forget that a sharemarket is really just a mechanism to facilitate the transfer of ownership of small parcels of the world’s leading companies from one person to another. For every buyer, there must be a seller (as there is only ever a finite number of shares available for each stock), meaning that market forces of supply and demand are at work, just like every other market place in the world.

As financial advisers, it’s our solemn duty to help our clients forget the white noise of those who generate an income from internet clicks and focus on what they can control, and what’s important to them. That said, it’s not a bad idea to revisit some fundamentals of how markets work and what may be on the horizon.

Let’s start with some mistruths about stock market crashes. If a market was to truly “crash” it would cease trading completely. There’d be no more buyers, only sellers, who couldn’t sell what they want to sell because there’s no more buyers!

But remember, for every stock sold, there’s a buyer, meaning that either the people buying when everyone else is selling are really stupid, or they are the smartest people in the room. Because really, you wouldn’t buy something that’s falling in value right? I mean, you wouldn’t buy shoes, or a car, or a house, when the price has fallen would you? Maybe if you were to buy a slice of a profitable, well managed, low debt, market leading company with strong future growth prospects at a lower price than what was available previously then perhaps that would be smart, knowing that once the “hysteria” dies down and people recognise the potential of the company in question, people will buy the stock again, which will push the price up to where it should be.

The best example I can give is from my own personal experience. I bought some Commonwealth Bank shares in 2008 when they were trading at $52 per share. Within about 6 months Lehmann Brothers collapsed, sending the stock market into the final death throes of the GFC. My CBA shares dropped to $24 per share! But a funny thing happened, CBA still made their usual $6 billion profit that year. They still paid their usual dividend that year (in fact it was higher than previous years’ dividends in real dollar terms). So despite the share price halving, it was business as usual for the Commonwealth Bank.

That experience provided a valuable lesson for me – the share price is only a point in time price, but not always a true picture of how a company may be faring in the real world. Sometimes prices are undervalued (like in 2008) and they provide the best buying opportunities. For the record, the CBA share price hasn’t done too badly since:

As Warren Buffet said, “price is what you pay, value is what you get”.  But CBA is just one stock, and a market leader at that. What if you were to look at the entire Australian market over a period of time?

How about the All Ordinaries index over the past 30 years:

30 year graph of the All Ordinaries Index.

There’s two significant downturns there: the 1987 stock market crash (which now looks like a minor blip) and the 2007-09 Global Financial Crisis (the 2000-02 Tech Bubble or 1994 Bond Crisis don’t even make an impact on the graph). If you just looked at the downturns alone you’d probably get vertigo given how steep they were, but what about the months and years leading up to them? That’s a steep incline leading up to both events, much faster than the overall trend line that shows a market steadily increasing over time. It shows how an irrational gain (sparked by those who wanted to get in while the going’s good) followed by an irrational loss (sparked by panic and fear as everyone tries to bail out). If you were to put a finger on your screen over each of those events you’d be wondering what all the fuss was about.

The lesson to learn is, don’t worry about a freakish weather event when the climate is generally sunny and mild. You can’t control the irrationality of others. You can, however, control your emotions, invest for the long term in quality businesses, accept the dividend cheques that come your way (or ideally reinvest them into more shares) and accept that there will be bumps along the way whilst the market rises over time (as the impressive weight of historic evidence tells us will happen).

So, what headwinds may be on the horizon?

  • The US market may suffer a pullback when their Quantitative Easing program ceases over the coming year or two. This is where the Federal Reserve advocated billions of dollars be printed (which are passed onto banks who then lend onto consumers)  to flood the US economy to help stimulate their slow economy. Shares have been a big beneficiary of this additional money, but when the money ceases the lower investment in the market may lead to share price falls. The old adage says that when America sneezes Australia catches the cold, so there may be an impact on our market too.
  • Interest rates are likely to rise in Australia next year, after sitting at all-time lows for the past two years. This may impact on house prices and stocks (as companies can’t borrow as cheaply as they can now, potentially stunting company growth), and may attract foreign investors who can get higher interest rates on cash deposits here than they can overseas.
  • The Australian dollar may fall a little further, which will help our export market but not your spending power when travelling overseas.

This is all crystal ball stuff, of course, but I hope that an understanding of the inevitable ups and downs of the market will ensure that the next “doom and gloom” headline doesn’t interrupt the enjoyment of your morning coffee.

It’s my job to work as my client’s financial ‘lifesaver’ to ensure that they swim between the flags and that they don’t get in over their heads.