Economic and market prospects
Brian Parker CFA
Investment Strategist
MLC Investment Management
General advice warning and
disclaimer
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How to build wealth and sleep
soundly at night
1. Supply capital (equity or debt) to businesses (lots of them)
2. Be patient
3. Understand (and be comfortable with) the risks you are
taking (you have to be able to sleep at night!)
4. Be realistic, not greedy
In recent years, too many people have made building
wealth too complicated too opaque and too risky
John Maynard Keynes
•“Speculators may do no harm as
bubbles on a steady stream of
enterprise. But the position is
serious when enterprise becomes
the bubble on a whirlpool of
speculation. When the capital
development of a country
becomes a by-product of the
activities of a casino, the job is
likely to be ill-done.”
•- Keynes, General Theory 1936
Hyman P. Minsky 1919 - 1996
• “… over periods of prolonged
prosperity, the economy transits
from financial relations that make
for a stable system to financial
relations that make for an
unstable system. In particular,
over a protracted period of good
times, capitalist economies tend
to move to a financial structure in
which there is a large weight to
units engaged in speculative and
Ponzi finance. “
• - Minsky 1992
US housing: the state of play
..helping to create a huge overhang of
unsold homes
Home sales have plummeted..
8500
'000 annualised
12
7500
10
6500
8
5500
Unsold single-family homes to total sales ratio
6
4500
Total home sales (new + existing)
3500
4
2
2500
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Jan-08
Jan-85 Jan-88 Jan-91 Jan-94 Jan-97 Jan-00 Jan-03 Jan-06 Jan-09
..and housing is now much more
affordable
Housing starts have fallen in response
to sharply weaker demand..
150
2500
Index of housing affordability
140
2000
130
1500
120
110
1000
100
Housing starts
500
Jan-93
Jan-96
Jan-99
Jan-02
Jan-05
Source: Thomson Financial Datastream
Jan-08
90
Jan-88
Source: Thompson Financial Datastream
Jan-92
Jan-96
Jan-00
Jan-04
Jan-08
The US economy is already in recession
– just ask consumers
140
University of Michigan - Consumer Sentiment Index
120
100
80
60
40
Expected conditions
20
Jan-79 Jan-83
Jan-87 Jan-91 Jan-95
Source: Thomson Financial Datastream
Current conditions
Jan-99 Jan-03 Jan-07
GDP growth has slowed a lot and the
leading index looks lousy
10
Annual change %
8
Conference Board leading index
Real GDP
6
4
2
0
-2
-4
Q1 1988
Q1 1993
Q1 1998
Q1 2003
Q1 2008
Business surveys are more timely
than GDP and look awful.
75
Index
70
65
60
55
50
45
40
35
ISM Manufacturing index
30
ISM non-manufacturing index
25
Jan-79
Jan-84
Jan-89
Jan-94
Jan-99
Jan-04
Jan-09
Bank failures soared even before the
recession had really hit!
No. of US bank failures
18
16
14
12
10
8
6
4
2
0
2000
2001
2002
2003
2004
Source: FDIC. 2008 figure is at as 5 November.
2005
2006
2007
2008
De-coupling in Europe and Asia?
Sharemarkets don’t buy it
0
% change in share prices from 2007 peak
-10
-20
-30
-40
-50
-60
-70
U
K
U
S
Th
a
Ta i
iw
an
Ja
pa
n
Ko
r
M ea
al
ay
Eu sia
ro
zo
ne
Au
st
ia
In
do
ne
s
Si
ng
H
K
C
hi
na
-80
Here comes the cavalry
Global official interest rates
10
%
• All the major central banks have
cut interest rates, and there is
more to come.
9
8
• Governments finally ‘get it’
7
6
• “We are in very uncertain times.
But, for the first time we can now
say with confidence that the major
developed countries' governments
are doing all in their power to deal
with this crisis.”
5
4
3
2
1
0
Jul-08
Aug-08
US
Canada
China
Sep-08
Oct-08
Eurozone
Japan
Australia
UK
India
NZ
Source: Thomson Financial Datastream
- Bridgewater 13 October 2008
Money market conditions are
improving
%
6.5
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Mar-07
3mth Treasury bill rates
3mth USD LIBOR
US Federal Funds target
rate
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Global economic and investment prospects
• US is in recession now and the other major economies are following..
• ..but the Chinese economy is relatively well-placed to weather the storm
• Not a textbook recession – financial crises take longer to unwind,..
• ..however, the economy and financial markets will recover (every crisis,
every recession, every market downturn comes to an end!)..
• Governments finally ‘get it’.
• Opportunities are emerging (the world’s best professional investors are
BUYING)
• We are most unlikely to see a repeat of the kind of investment returns
seen in recent years.
Australia in summary
• Economy grew at an annual rate of less than 2% during H1 2008 as
consumer spending slowed to a crawl..
• ..and this has happened BEFORE the bulk of the impact of past rate
hikes could be expected to hit the economy
• Bright spots?
•
•
•
•
•
Exports (at least in volume terms)
Huge pipeline of investment spending
Housing activity should rebound in 2009
Authorities (RBA and Govt) have acted aggressively and early
Sharply lower $A is good news
• RBA’s inflation worries will evaporate as domestic demand eases. RBA
has already done a lot, but more rate cuts to come.
The bad news
Retail sales figure for September
was a shocker - trend is slowing
2.5
Consumer sentiment just above
levels not seen in seventeen years
%
140
130
2.0
120
1.5
110
1.0
100
0.5
90
0.0
80
-0.5
-1.0
-1.5
Oct-05
70
m/m% sadj
m/m% trend
Oct-06
60
Oct-07
Oct-08
50
May-79 May-84 May-89 May-94 May-99 May-04
Bad news waiting to happen?
300
Real (inflation adjusted) house prices. March quarter 1988 equals 100
US
250
UK
Aust
200
150
100
Sources: Datastream, RBA, MLC Investment Management
50
Q1 1988
Q1 1991
Q1 1994
Q1 1997
Q1 2000
Q1 2003
Q1 2006
Let’s keep the recent weakness in
perspective
7000
ASX300 Index
6500
6000
5500
How will this look in
5 years’ time?
10 years’ time?
5000
4500
4000
3500
3000
Source: Thomson Financial Datastream
2500
Nov-03
Nov-04
Nov-05
Nov-06
Nov-07
Nov-08
1987
1050
Australian share prices - daily
1000
950
900
850
800
750
700
650
600
550
500
Jul-87
Aug-87
Sep-87
Oct-87
Nov-87
Dec-87
1987
1050
Australian share prices - daily
1000
950
900
850
800
750
700
650
600
550
500
Dec-86 Jun-87 Dec-87 Jun-88 Dec-88 Jun-89 Dec-89 Jun-90 Dec-90
1987
1800
Australian share prices - daily
1600
1400
1200
1000
800
600
400
200
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
1987
2500
Australian share prices - daily
2000
1500
1000
500
0
Dec-82
Dec-84
Dec-86
Dec-88
Dec-90
Dec-92
Dec-94
Dec-96
1987
4000
Australian share prices - weekly
3500
3000
2500
2000
1500
1000
500
0
Dec-79
Dec-82
Dec-85
Dec-88
Dec-91
Dec-94
Dec-97
1987
9000
Australian share prices - weekly
8000
7000
6000
5000
4000
3000
2000
1000
0
Dec-75
Dec-80
Dec-85
Dec-90
Dec-95
Dec-00
Dec-05
1987
10000
Australian share prices - weekly
9000
8000
7000
6000
5000
4000
3000
2000
1000
0
Jan-73
Jan-78
Jan-83
Jan-88
Jan-93
Jan-98
Jan-03
Jan-08
There’s always things to worry about
•
•
•
•
•
•
•
•
•
•
The 1929 crash
Great depression
WW II
Korean War
Cuban missile crisis
Vietnam War
OPEC oil crisis I
OPEC oil crisis II
Latin American debt crisis
Australia’s ‘banana republic”
moment
• 1987 stockmarket crash
•
•
•
•
•
•
•
•
•
•
•
•
The fall of the Berlin Wall
Iraq War I
US savings and loan crisis
The recession we had to have
Bond market crash 1994
Mexican debt crisis 1995
Asian crisis 1997
Russian debt/LTCM crisis
Tech wreck
September 11
Afghanistan
Iraq War II
..“Maybe I should head into cash
until things settle down?!?”
• Need to get 2 calls right – when to get out, AND
when to get back in
• Macro indicators are often useless when it comes to
timing these things
• Cash returns on offer ain’t what they used to be
• Dalbar (2007) Investor performance 20 years to end
2006:
Market return (S&P500) 11.8%
Investors return 4.3%
The difference? Trying to time markets!
Australian market downturns and their
aftermath
…5 years' later
1973 - 1974...
120
Total return index
110
100
90
200
Total return index
180
160
140
80
120
70
60
50
100
80
40
60
30
40
20
Jan-73May-73 Jul-73 Oct-73 Jan-74 Apr-74 Jul-74
20
Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 Jan-78 Jan-79
Australian market downturns and their
aftermath
…five years' later
1980 - 1982
Total return index
Total return index
920
370
820
320
720
620
270
520
220
420
320
170
220
120
Nov-80
May-81
Nov-81
May-82
120
Nov-80
Nov-82
Nov-84
Nov-86
Australian market downturns and their
aftermath
…five years' later
1994
1800
Total return index
3900
Total return index
1750
3400
1700
1650
2900
1600
1550
2400
1500
1900
1450
1400
Feb-94 Mar-94 May-94 Jul-94 Sep-94 Nov-94
1400
Feb-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99
Australian market downturns and their
aftermath
…five years' later
Emerging mkts/LTCM crises
2800
Total return index
4000
Total return index
3800
2700
3600
2600
3400
3200
2500
3000
2800
2400
2600
2300
2400
2200
Apr-98
Jun-98
Aug-98
2200
Apr-98 Apr-99
Oct-98
Apr-00 Apr-01
Apr-02 Mar-03
Australian market downturns and their
aftermath
..five (and a bit) years' later
Post tech/Sep 11, et. al...
4000
Total return index
Total return index
10000
3900
9000
3800
8000
3700
3600
7000
3500
6000
3400
3300
5000
3200
4000
3100
3000
Jun-01
Dec-01
Jun-02
Dec-02
3000
Jun-01
Dec-02
May-04
Nov-05
May-07
MLC performance update
•
•
•
•
•
No sub-prime mortgage exposure
REIT exposure miles below peers, and..
..Global REIT exposure has fared better than Australia
Australian equity performance has recovered
Portfolios are extremely well-diversified, but…
…we are in the risk management business, not the risk
avoidance business
Some questions…
• Do you know your own tolerance for risk (the ‘sleep-at-night’ test)?
• Do you know your financial goals and needs (both near term and
longer term)?
• Do you understand what kind of investment returns are achievable
and sustainable over time?
• Is all of this embodied in a financial plan produced by an
appropriately qualified financial adviser?
If the answer is ‘yes’ to all of the above, then nothing that’s happened
in markets recently should cause you to do much at all!