“The right time to invest is when there is blood in the streets.” That was the famous dictum of Nathan von Rothschild, who would have known.
Rothschild made one of the all-time great financial killings by engineering a panic after the Battle of Waterloo. He dumped all of his stock in London, creating a stampede for the exits: investors knew that Rothschild was better-informed about happenings in Europe than the government, so if he was selling, Napoleon must have beaten Wellington.
Rothschild, of course, knew that the reverse was true. But if he could get the market to think the opposite for a few days, he could ‘get set’ in time for the euphoria that the official news of Waterloo would bring.
The panic around the financial markets at present is every bit as raw as that in London in June 1815. Metaphorically, there is blood in the streets, with banks failing, the credit markets frozen and investors prepared to accept virtually no yield on short-term US Treasuries so as to place money where it can’t be lost.
At time of writing, the rejection by the US lower house of the administration’s US$700 billion bail-out plan for the financial markets had sent northern hemisphere markets into a tailspin, meaning that Australian investors are staring at a 30 per cent bear market that is about to be hammered even lower.
It’s capitulation, head-for-the-hills time on the stock market. But paradoxically, that makes it a good time to invest.
Shane Oliver, head of investment strategy and chief economist at AMP Capital Investors, says there is a good chance that we have “actually seen the bottom” in shares. “If not, we’ve come very close,” he says.
“What we know from history is that when a bear market rebounds, the really big gains are made in the transition from the panic stage to a more normal stage – the index tends to rally by about 32 per cent in the first 12 months,” says Oliver.
“So it’s quite possible when the rebound comes, the market could put on 30 per cent quite quickly. I don’t think anyone should assume that that’s going to be sustained, but the market could recover quite quickly.”
Oliver was heartened that the Australian market “did not make a new low” when it fell 4.3 per cent on the Tuesday following the US Congress’ rejection of the bailout plan. “Given that major bear market lows often involve some sort of retest of the low, a fall back to last week’s low levels is a distinct possibility. But after expecting a slump into the normally weak September/October period which we have now seen, I am now more confident that shares will stage a decent rally into year-end and then through 2009.”
In the first quarter of the financial year, Oliver says, the Australian index fell 12 per cent. But he insists that it is realistic for the market to make a positive return in 2008-09.
Regaining 12 per cent to return to the black sounds a difficult proposition, says Oliver, but he points out that in late September, the index rose by 8 per cent in two days. “That’s the kind of volatility that’s out there, but it can go both ways. All the market needs is some form of positive signal, like the bailout package being passed, and worldwide interest cuts, and there is a lot of pent-up buying demand, from traders and investors who are sitting in cash, and don’t forget the underlying flow of superannuation money. There comes a point when the market has fallen by so much, investors think it is cheap and attractive.”
Oliver makes the point that with 30 per cent stripped from the Australian market, shares are trading on a forward (prospective) P/E ratio of 10.8 times earnings – versus a ten year average of 15.1 times. That is the cheapest they have been for 19 years. And on yield grounds, he says bank share prices have fallen to the point where their dividend yields are now 7-8 per cent.
Investors should not forget the contribution of dividends, he says: if the market could get back to breakeven, the dividend yield will give an investor a 5-6 per cent gain for the year. “Anything above that would be a bonus,” he says.
Simon Kent-Jones, investment strategist at Ord Minnett, says that when “it seems like the world is ending,” historically that has proven to be a good time to invest.
“Clearly, when the market falls like this, stocks become cheaper. If you’re looking for a cheap entry point, this is the cheapest the market has been for many years. One of the compelling reasons why you would consider investing at this point is that cheapness. Price/earnings (P/E) ratios are exceptionally cheap on historical grounds. But no-one will be able to time precisely the perfect entry point: you’ll turn yourself inside out trying.
“The indications are that we’re close to the bottom, if not already there. But the main determinant of whether you will do well if you buy in now is how much time you can give the investment. If you’ve got a five- to ten-year investment horizon – which really should be your minimum horizon to invest in shares – then the timing is good, the value looks compelling. But if your investment horizon is six to 12 months, you couldn’t say the timing is good now.”
David Reid, managing director of research firm Andex Charts, has produced numbers that show quite starkly why the market’s relative cheapness makes it an attractive long-term investment – because it usually is.
Andex Charts has calculated the returns made by investments in the main accumulation index (share price growth plus dividends) of the Australian sharemarket, made at every month end since 1 January 1950, and held for ten years.
In the period to 31 August 2008, there have been 585 ten-year investment periods – and not one had made a loss. The lowest ten-year return was 2.9 per cent a year (for the ten years ended 30 September 1974), while the best return was 28.7 per cent a year (for the ten years ended 30 September 1987. The median ten-year return comes in at 13.3 per cent a year.
The most recent completed ten-year return – for the decade to 31 August 2008 – is 12 per cent a year. This is despite a 13.1 per cent fall in the last 12 months of that period. Reid says the index would need to have fallen by 66 per cent in September to produce a negative ten-year return.
The lesson in these numbers is that if you are certain that you can give a sharemarket investment (that is, in the accumulation index) time, you can be confident that it will make money for you. A financial planner would get into trouble for describing the sharemarket as capital-guaranteed, but statistically, the accumulation index is, if you hold it for ten years.