The global resources boom paints a much brighter economic outlook for Australia than the United States, according to one of the world’s leading investment thinkers, Dr Burton Malkiel.
Malkiel, of Princeton University in the US, says there is no end in sight to the resources boom, and strong global demand will lift commodity prices. And, the author of the widely read investment book entitled, “A Random Walk Down Wall Street”, says the world should get used to higher oil prices over the longer term.
“I think there may be a lot of speculation in the price of oil, but I think there is something fundamental behind the rise in oil and raw materials and that is the growth in China and, to a somewhat lesser extent, India,” Malkiel says. “I think that will continue and I think that 10 years from now, oil and natural resources will be much more highly priced than they are now… this is a long term trend. So if you don’t like $128 oil now – it might be $80 next month – but five years from now, it will be more expensive in my view.”
In a wide-ranging address to an audience of almost 1000 people at the Grand Hyatt in Melbourne this week, Malkiel did not pull any punches regarding his outlook for the US economy.
He says investors can expect more regulation of its financial system after the bail-out of US investment bank Bear Stearns flowing from the sub-prime meltdown. It will be more difficult to get loans in the US at a time when house prices are falling and repossessions are rising. And equity in US housing can no longer be treated as an ATM machine.
And, he warned, the effects from the sub-prime crisis were not over.
Malkiel, a past appointee to the President’s Council of Economic Advisers, told an audience of investors and analysts: “There’s more bad paper out there. It’s not simply sub-prime mortgages, it’s credit card debt. We Americans are prodigious spenders and we have a zero savings rate. We have a lot of paper out there that hasn’t even had its problems yet.” He says the US will come though the sub-prime meltdown over time. But at the moment, US Government bonds are yielding less than 4 per cent, and the high oil price is hurting consumer spending, which accounts for 70 per cent of GDP. “I am actually more optimistic about Australia than I am about the US.”
The carnage caused on financial markets resulting from the US sub-prime crisis supports Malkiel’s long-held view that investors should use index funds, particularly in volatile times. He says that US share index funds on average have outperformed active equity fund managers over five-to-10-year terms. Better returns from index funds were enhanced by lower fees and charges as managers are not trying to out-perform the index though constant trading. Capital gains tax on profits can eat into any fund’s returns, but indexing can take advantage of discounts because of its long term strategy.
Malkiel argues that investors are better off “throwing a towel or a blanket over the stock pages” than choosing individual stocks, or searching for a “needle in a haystack” top performer. Rather, buy the haystack. Indexing is a buy and hold strategy. Higher turnover means higher expense. He says: “Critics of indexing say its guaranteed mediocrity; for me, it’s above average performance. The analogy I like to make is supposing you went out to the golf course and you could be assured of playing every round with par. That’s basically what you get with an index fund, and it’s not an average performance, it’s an above average performance. And the great thing about indexing, even in a down year, you still receive an average return.”
Malkiel was not suggesting that investors index 100 per cent of their portfolios. Not even he does that. “Telling investors that they can’t beat the market is like telling a six-year old that Santa Claus doesn’t exist,” he says. “But what I do suggest to you is that the evidence in favour of indexing all over the world is strong enough, so, that at least, the core of your portfolio should be indexed. You get the broad diversification, you get the good tax management, you will get the benchmark performance and you have the low cost.”
But an alternative view on index funds was put by Andrew Doherty, of Morningstar. Doherty, a researcher, says index funds are certainly a useful investment strategy, but do not necessarily post superior returns, even over the longer term. He says index funds certainly suit investors who do not want to keep a close eye on the market, but these funds can also mix “dud businesses” with good companies. Doherty says actively managed equity funds, holding solidly performing companies, can easily out-perform the index huggers. And good managed companies can absorb market volatility, and benefit from a “flight to safety” when investor optimism returns. “Over the longer term, good quality portfolios can and will outperform the index,” he says.
Malkiel’s message to investors in times of sharemarket volatility is to “stay the course”. Do not let get emotions get in the way of considered and sensible objectives. Following others into the market on a whim of optimism, or selling on fear during market downturns can wreck a portfolio. To highlight this point, Malkiel says more money went into US equity mutual funds than ever before during the last quarter of 1999 and the first quarter of 2000 – at the height of the internet bubble. And we all know what followed. Yet when the sharemarket was approaching its low point in the third quarter of 2002, investors sold on fears the sky was falling in. The average investor has a history of buying at the top and selling at the bottom.