Tuesday 30th September 2008
The Financial Fortnight That Was
In This Issue
Quote for Consideration
Financial Topic Demystified - The Debt Crisis
Fascinating Financial Fact
Market News
What to do in current market conditions?
Other Websites of Interest
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Greetings! 
 

Welcome to the latest edition of The Financial Fortnight That Was.

What a difference a night makes.  Last night I had the email ready to send and woke up this morning to the news of the rejection by US Congress of what is being referred to as the Bailout Plan.  However, the leaders of Congress (at the time of writing) have pledged to continue to work towards a financial rescue bill.

 

On top of this political tension, the past fortnight has seen some turbulent conditions on investment markets throughout the world.  We devote this edition to looking at those issues.  In this edition we take a look at the debt crisis, provide a summary of the bailout efforts of the US government as set out in the proposed Emergency Economic Stablization Act, provide a summary of the movements in markets over the past fortnight and look at what to do in the current market conditions. We hope that you find the material informative and relevant!

A Quote for Consideration 

"The current financial crisis calls out for new products and services as well as more, not less, information about what is safe and profitable in the future environment."

Jeremy J. Siegel, The Wall Street Journal,
"The Resilience of American Finance", 9/16/08

 

Financial Topic Demystified 
The Debt Crisis
 

In this edition of our email newsletter it would be remiss of us, given the extremely volatile market conditions being experienced on investment markets, to avoid discussing what is being widely referred to as the Debt Crisis.  Last week we made a presentation to interested clients, via meetings and teleconferences about the current situation.

 

A copy of the presentation can be found on our Seminar Presentations page on our website.

 

The following is a brief summary of the discussions

 

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The debt or credit crisis started with the selling of mortgages to people who could not afford them.  They were sold by salespeople on commission.  These loans were then sold on to other financial institutions. As such the initial lenders were not worried about the credit worthiness of the borrowers because they were just selling the loans on to other institutions.

 

Now these loans were non-recourse loans.  If the borrower could not pay back the loan the lender could take back the property from the borrower but without any further claim on the assets of the borrower.   Property prices have fallen significantly in value so that the value of the assets are now much less than the original loan values.

 

These loans were bundled together, sometimes with further borrowing, into various products including Collateralised Debt Obligations (CDOs).  In Australia some superannuation funds, local councils and banks invested in CDOs.

 

The problem has now become that no-one trusts anyone in debt markets.  If these CDOs can cause an investment bank to fail then no-one wants to lend money to an institution that might have significant exposure to them.

 

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Where to from here?

 

We do not want to diminish what is happening in any way.  This is a very serious financial problem; however there have been others that have gone before.  The media enjoys reporting fear and greed which makes it all the more difficult to focus on the fundamentals.

 

In terms of Australian banks, the banks in the USA that have fallen have been investment banks.  Australia's banks are better capitalised, our government's credit rating is AAA and can raise cheap debt if necessary, the Reserve Bank has not had to 'prop up' any institutions and the official cash rate is 7% giving them room to cut rates if growth slows.

 

In terms of the real economy:

  • Unemployment is at historical lows (less than 5%)
  • There is no serious expectations of a recession
  • The economy is forecast to continue to grow (albeit at a slowing rate - which is not a bad thing in that it keeps inflation under control)
  • An International Monetary Fund (IMF) study suggests Australia is well placed to weather the global economic downturn
  • Even in the USA the 'real economy' seems to be surprisingly strong, unemployment is reasonable, consumer spending strong - and against forecasts they seem to have avoided a recession up till now (although that may change in the future).

The Bailout which is being hotly debated in Washington (& all over the world), will potentially improve the situation by removing "toxic" debt out of the companies making it easier for companies to "trust" each other and lend and borrow with certainty.  Our Fascinating Financial Fact section sets out the details of the plan.  However it is not a magic pill and what seems to be really needed is a floor under house prices in the US. 

 

What is already priced into the value of shares?

 

There is an obvious desire to sell shares, and put the money into cash at such a difficult time.  However, the price of shares at the moment must reflect a great deal of fear - from the USA problems and the reporting of this as a 'crisis'.

The value of shares at the moment would likely reflect:

-         The probability of a USA recession

-         Continued problems in credit markets

-         A slow down in company earnings

 

All this being said, it is a very difficult time on investment markets and a really good time to get in contact with your financial advisor to discuss how it impacts your individual circumstances.
 

Fascinating Financial Fact
 

Proposed Emergency Economic Stabilization Act of 2008

 

The key points of the EESA are:

  • Phased introduction of funding, with US$250 billion made available immediately to the US Treasury for purchase of problem assets. This amount could be increased to US$350 billion at the President's request.
  • A limit of US$700 billion is set for all purchases and allows Congress to veto purchases above the limit.
  • US taxpayers are given ownership interest in companies that take advantage of the bailout package.
  • Profits from the sale of Government-owned assets, if any, will be used to retire the US federal debt and a portion set aside for a federal housing authority.
  • The US Treasury secretary will coordinate with foreign financial authorities and central banks about establishing similar rescue programs.
  • Limits excessive compensation and bonuses for executives at companies that sell mortgage assets to the Treasury. Companies that participate in the plan will be prohibited from offering 'golden parachutes' to their executives.
  • A Board composed of the Federal Reserve Chairman, the Treasury Secretary and the Chairman of the Securities and Exchange Commission, the Director of the Federal Home Finance Agency and the Housing and Urban Development Secretary, will oversee and monitor the implementation and progress of the bailout plan.
Market News

ASX P/E Ratio and Dividend Yields

The P/E ratio is a common broad indicator of the price of shares.  It is a calculation of the price of shares compared to expected earnings.   A higher ratio indicates that share prices are more expensive.  The historical P/E ratio for the ASX has been between 14 & 15.  The dividend yield is the calculation of dividend payments divided by the market capitalisation of the company or index.  The historical average in Australia is around 4%.

As of September 23rd the P/E ratio for the S&P/ASX 200 was 10.87.  The dividend yield was 4.59%.


Market Indices

Since our previous edition, most growth asset markets have fallen in value.  The S&P ASX200 Index has actually remained steady rising by 0.02% from 12th of September to the 26th of September.  It is now down 24.33% from the same time last year and down 22.64% for the calendar year so far.  The MSCI World Index - ex Australia, a measure of the global market, has fallen 3.92% over the same period.  The index is down 23.07% from the same time last year and down 20.89% for the calendar year so far.

 

Emerging markets have also experienced negative movement with the MSCI Emerging Markets Index falling 2.75% since the 12th of September.  This index is down 27.27% from the same time last year and down 30.26% for the calendar year so far.

 

Listed property has not been spared over the past fortnight.  Australian listed property trusts have fallen 1.37%.  The index is down 41.38% from the same time last year and also down 31.20% for the calendar year so far.

 

The S&P/Citigroup Global REIT - Ex Australia Index has fallen over the fortnight by 3.31%.  This measure is down 10.91% from the same time last year and down 0,10% for the calendar year so far.

 

Exchange Rates

As of 4pm the 26th of September, the value of the Australian dollar has risen against major benchmarks since the last edition.  It is up against the US Dollar at .8311.  It is now down 4.82% from the same time last year and down 5.73% for the calendar year so far.  Since September 12th the Aussie has also risen 2.02% against the Trade Weighted Index, with the index now at 65.5.  This puts it down by 5.48% since the same time last year and down 4.66% for the calendar year so far.  (The Trade Weighted Index measures The Australian dollar against a basket of foreign currencies.)

 

General News

Westpac and the Association of Superannuation Funds of Australia (ASFA) have released their latest national Retirement Standard - Westpac-ASFA Retirement Standard.  The report shows that petrol, health and food prices are driving up the costs in retirement.  Check out our blog for more details - Retirement costs rising.

 

The Australian Bureau of Statistic have reported that the net overseas migration to Australia is the highest on record for the year ending March 31st.  Net overseas migration was just under 200,000 and accounted for over half (59%) of Australia's population increase.

 
What to do in current market conditions?
Scott's Financial Happenings Blog - Posted Thursday 18 September 

This morning I have read what I feel is a very useful piece on Vanguard's website - Just when you thought it was safe to go back in the water.

 

The article gives a brief summary of current happennings on the markets and concludes by asking what action, if any, should investors be taking?

 

It suggests the following courses of action (directly taken from the article):

  • Do nothing. Sit it out and wait for the upturn. The beauty of this strategy is that you stay invested so when the market recovers you will benefit from any upturn. History shows us that sharemarkets have suffered many setbacks over the years and recovered to higher heights. Check out Vanguard's updated interactive index chart for a long-term market perspective.
  • The truth is there is no right or wrong time to invest and being out of the market can cost vital performance. An AMP Capital report found that investors who stay in the market end up better off than those who flee. In fact, an investor with a $100,000 Australian share portfolio who stayed in the market over the last 10 years to 30 May 2008 would have ended up $179,544 better off than one who missed the best 30 days of sharemarket performance (based on the ASX 200 Accumulation Index to 30 May 2008).
  • If you have reservations about your investment strategy in the current investment climate it can be well worthwhile seeking the advice of a professional financial adviser. An adviser can sit down with you and talk you about your personal circumstances, investment goals and suggest the most appropriate strategy for your needs. This is especially important if you have a high growth strategy and are finding it difficult to sleep at night.
  • Drip feed your investments. Part of the beauty of compulsory super is that your money isn't invested all at once. Rather, a set amount is invested at regular intervals. This strategy, called dollar cost averaging, can help to average out market fluctuations over time. This is a strategy the self-employed can take advantage of as well.
  • Double check your risk profile. You may find that you overestimated your risk tolerance level when markets were more stable. Steve Utkus says investors can overestimate the odds and become overconfident in rising markets. Risk profiling is best conducted under the guidance of a professional financial adviser.

 

There is no surprise that I fully concur with the thoughts pointed out by Vanguard.  I particularly like the last point.  Now is the time to be reconsidering your risk profile.  Risk profiling is a difficult task.  When you are asked the question how would you feel if your investments fell by 10,20,30,40% it is difficult to provide an accurate response if you have never experienced such falls.  After 9 months (or more for listed property investors) of really tough conditions the question to be asking yourself is how have you gone handling not only the 25% or more falls on equity markets but also the significant turbulence (volatility)?

 

If your answer is that you are finding it extremely uncomfortable it may make sense to ease back on your growth asset allocation.  Most likely this will have occurred automatically as growth investment values have fallen and defensive assets remained steady but produced income.  However a decision will need to made when rebalancing your portfolio whether to set your growth assets back at the original percentage level. 

 

If your portfolio still has too great an exposure to growth assets it may have to be a gradual process to rebalance to a more defensive position as ideally you do not want to be realising losses and then see the market turn back up sharply.  One way would be to make sure you don't reinvest income and dividends as they come into portfolios, rather set these aside in cash and fixed interest security investments and by doing so rebalance your portfolio towards a more defensive setting.

 

Please get in touch if you wanted to discuss any of these points in more detail.


Regards,
Scott Keefer

 

Other blogs over the past fortnight have included:

 

15th September - Don't expect out-performance from growth assets over 5 or even 10 year periods

 

20th September -  Summary of Sound Investing - September 19

24th September - Coping with the Investment Market Crisis

 

25th September - Retirement Costs Rising

 

Click here to be directed to Scott's Financial Happenings Blog

 

Other Websites of Interest 

Our seventh site in the series is from Evanson Asset Management - http://www.evansonasset.com/index.cfm?Page=2

 

Evanson Asset Management is a registered investment advisor in the USA.  Their site provides some useful information particularly in relation to the use of a passive investment approach as compared to an active approach but also in relation to portfolio design, asset allocation and a review of relevant research.  It is not a pretty website but contains lots of useful information.


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We hope you have enjoyed reading the latest edition.  If you have any comments or suggestions for future topics please do not hesitate to get in contact.
 
Have a great fortnight!
 
Cheers,
The Two Scotts
 

The Financial Fortnight is a publication of A Clear Direction Financial Planning.  It contains general financial advice.  Readers should check this advice with a professional financial adviser before acting on any of the material contained in this email.

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