13 August 2008
The share market is not for the faint-hearted, and investors who experienced the highs and lows of the late eighties would be fastening their seat belts.
But gloomy times also make for the best aphorisms from experts too.
The 'sage from Omaha' Warren Buffet has said: "The real secret to investing is to be greedy when others are fearful and fearful when others are greedy."
Whereas the recently departed Sir John Templeton stated that: "For those properly prepared in advance, a bear market in stocks is not a calamity but an opportunity".
One of the most experienced economists and investors of the 20th century John Maynard Keynes summed it up by stating - markets can remain irrational longer than you can remain solvent.
But perhaps Sir John Templeton's most remembered adage is: "The time to buy is at the point of maximum pessimism."
Bear market blues
Pundits are debating the merits of a bear market - when the market has sustained a greater than 20 per cent fall for an extended period.
And inevitably investor chat is about when is the best time to buy? Has the market hit bottom? How low will it go? What signals should we be taking notice of?
Head of Investment Market Research at Colonial First State (CFS) Hans Kunnen says buying shares after the crash of 1987 would have been a good investment strategy.
"From the end of 1987 to the end of 1989, all major banks rose by more than 50 per cent as did BHP, Rio Tinto, Harvey Norman, Coca Cola, Caltex, Wesfarmers and QBE Insurance - all household names providing services at a profit.
"That's what businesses do and will continue to do in 2009".
One signal is the volatility index VIX, which the Economist reported as reaching level 30 in the US at the time of the Bear Stearns rescue.
The theory is that when volatility is high, markets are falling.
But it still has not reached the heights seen in 2002 or 1998, when the hedge fund Long Term Capital Management had to be rescued after the default on loans by the Russian Government.
Both incidents pushed the index above 40, and proved to be a good time to buy shares.
In Australia, "the equities market has dropped 14 per cent year-on-year but it's also been flat the last three months," says UBS's Executive Director, Head of Research & Investments, Piers Bolger.
Bolger says the volatile market is seeing investors becoming risk averse.
"The market has been over-valued for some time in our view, and we are now seeing a more risk-averse approach as risk is being re-priced".
"We are seeing the fallout from US sub-prime moving through credit markets and financial institutions. It will be a challenging environment for some time with low growth, higher inflation, and parts of the market under stress".
Is the market still over-valued?
A second signal for investors to be aware of is the price/earnings ratio.
The ASX is currently trading on a multiple of around 11 times forward earnings estimates, compared with the long-term average of about 15 times.
According to UBS, this is the lowest figure in 15 years.
But Bolger believes the market is still over-valued.
He says, "Excluding financials and materials companies, which generally trade at a discount, the price-to-earnings ratio of the market is generally not as low as suggested.
"That P/E average will be under further pressure; on individual metric perspective, this doesn't mean the market is cheap, particularly if earnings continue to disappoint."
CFS's Hans Kunnen says the All Ordinaries Index is currently trading on an earnings yield of 7.2 per cent. Over the past 12 months, this has moved as high as 9 per cent and as low as 7 per cent.
"Given the earnings yield is currently greater than the 10 year bond yield, this usually suggests that shares are cheap. However, it is important to consider how earnings will look in 2009 given a softer economic outlook and higher interest rates," Kunnen says.
But valuation is not the only thing that drives markets. In periods of panic prices can be driven down, as they can be pushed up in times of euphoria.
In times of market mayhem, some good buys can emerge.
Bolger believes that "good quality industrials have also been negatively impacted by the bad economic news, for example, companies such as Brambles and Toll, where we believe the fundamentals remain attractive."
"While we have seen significant falls in equities over the last six months or so, we still believe that the broader market is slightly expensive and will certainly remain under pressure over the next six to nine months, given the current environment.
"So there is a potential for shares to be 'cheaper' still as we head into the back end of the year," he says.
Hans Kunnen says no market slowdown is ever the same. Generally, more defensive sectors outperform but given the current market conditions, there is no guarantee that this will be the case.
"Currently, the weaker sectors include Listed Property Trusts, financials and consumer discretionary. These sectors are down around over 30 per cent since 1 November 2007".
He says the stronger sectors in the current downturn have been materials and energy. In past downturns, these sectors have suffered due to softer global economic growth and weaker commodity prices.
"However, higher energy prices and bulk commodity prices have seen these sectors outperform. Much of this is due to strong demand from China. This reinforces the fact that these are no ordinary times".
Investors are waiting for a snippet of good news to get back into the market. With the reporting season throwing up most of the bad news not only here in Australia, but overseas, investors should keep a close eye on the market.
A Merrill Lynch survey of global fund managers reported in the Economist recently found that a record number were overweight in their holdings of cash and underweight in shares, and most thought profit forecasts were far too high.
Bolger says, "market volatility needs to stabilize before some confidence returns to the market for investors. This will be dependent on the information flow from the US principally; a pick-up in economic growth, consumer sentiment, housing prices, inflationary expectations, energy prices etc - which are all intertwined to give investors the confidence to return to the market".
He says "If we are just looking at P/E multiples, this alone does not always capture the 'value' of the market, and investors should be aware and remain cautious of the fact that not all risk has been priced into what remains a highly volatile market."
"Market environment will be challenging most likely until end of Q1 2009 (and possibly longer), and investors need to realise it is not going to turn around overnight".
"The US needs to find a bottom in its housing market for that to occur, and you could argue they haven't found it yet. It will remain challenging".
"UBS maintains a cautious stance towards domestic equities and the market in general, but on a relative basis we see better value in global equities at this stage."
There is no doubt that drops in the oil price, lower inflation and better news out of the US, will go some way in calming the economic jitters.