Glass half empty or glass half full?

When I left work in 2007 the ASX was around 6500 and I’m still waiting to recoup my initial investment. We didn’t go into recession, our interest rates are at record lows, unemployment is manageable and we have a triple AAA rating. So why has the Australian market been wobbling around like a drunken sailor while overseas markets have improved?

It’s understandable to be concerned about market ups and downs, particularly when you’re retired. But there is a perception issue here. People often take the starting point of the ‘high’, ignoring that the high was far higher than you would have got elsewhere.

The graph below takes a different starting point. As you can see, an investor since 2000 would have been better off in Australian shares than in global shares. In 2007, global shares had just got back to where they were at the turn of the century, while Australian shares were double the levels in 2000.

The US sharemarket really span its wheels in the years leading up to the GFC. When the S&P 500 made a new high in 2007 it was only marginally above what it was in March 2000. In contrast, Australian shares had a fantastic run up to 2007. So our starting point before the GFC was a lot higher. We had a ‘higher high’.

Playing catch-up

The GFC saw both the Australian and the US markets fall about 55%. But since then our market has recovered more slowly and remains roughly 20% below its 2007 high. Let’s look at some reasons why.

• The natural ebb and flow of the markets. You typically find that you go through long periods of time when Australia is the place to be and then you go through long periods of time when the US is the place to be. The US had the tech boom in the 1990s while we were seen as old economy and out of fashion. And then it all reversed when their tech boom collapsed. We didn’t have any tech stocks and we got a huge lift-up from the commodities boom, emerging markets and the low Australian dollar—as recently as 2002 our dollar was at 48 US cents. Now the cycle has turned again.

• Our resources boom was underpinned by strong growth in China. But over the past few years there have been more question marks about China, with worries about Chinese economic growth and property weighing down our share market.

• When the US produces more oil and gas, it stays in the US and leads to lower prices. But when Australia ramps up its gas production, it leads to higher prices as that gas is destined for international markets. So their commodities story has been more positive whereas our recent commodities story has been more negative.

• The US dollar is still running at pretty low levels compared with its peak in 2002, while the Australian dollar is still running at pretty high levels after reaching a peak of US$1.10. This has impacted the competitiveness of Australian companies while their American counterparts get the benefit of a lower currency.

• There’s been a manufacturing renaissance in the US, with companies like General Motors expanding production, while in Australia GM is shutting down and vacating the market as a producer.

• And finally the US has had very easy monetary conditions, with zero interest rates and new money being printed through the Federal Reserve’s quantitative easing program.

You can’t ignore any of these factors in creating support for financial assets—for example, low interest rates have encouraged more Americans to put their money in the sharemarket.

Future headwinds

The slower bounce back in our market is indicative of a long-term change. We’re not down and out but it’s a lot tougher now.

The commodities tailwind has become a headwind. We still have to contend with a relatively high Australian dollar. And our household sector has a debt to income ratio that’s about 30% higher than the US.

All these are likely to act as a constraint on our markets. So for an investor looking for a diversified portfolio, there’s a case to have more in international shares than you might have had a decade ago.

But you need to be careful. It depends on what you’re after. If you’re looking for capital growth then there may be potential offshore. But in chasing that you could miss out on the higher income flows you may get from Australian shares.

Australian assets offer higher income generally. For example, our bond yield is 3.5%, while the US is 2.5% and Japan is 0.5%.

So it’s hard to pass the Australian market up even though it hasn’t recovered as quickly since the GFC.

And you can’t ignore the power of dividends. Dividends in Australia are much higher than the US and Australian investors also get franking credits, which mean the company has already paid tax. The dividend yield for Australian shares is about 4.5%, whereas in the US and other markets it’s nearer 2%.

So even investors who put their money down in 2007 should now be ahead if they reinvested the franked dividends they got along the way.

Safety first?

When you’re retired, perceptions change and it’s difficult to see the investment glass as half full. It can be tempting to look at the relative safety of defensive assets like bonds and term deposits.

And while there is some sense in becoming more defensive in retirement, you’ve got to be careful.

Historically we tend to think of bonds and term deposits as the place to go for yield. But the current bond yield is very low and so are bank interest rates.

One alternative investment option that seeks to deliver both income and capital growth is the AMP Income Generator.

The Income Generator takes account of the fact you’re going to get a pretty low yield from cash, bonds and term deposits, given the present low interest rates and market conditions, and therefore actively seeks out higher yielding opportunities like corporate debt or shares which offer income flows.

What you need to know
This document was prepared by AMP Capital Investors Limited (ABN 59 001 777 591, AFSL No 232497). This document, unless otherwise specified, is current at Monday 15 September 2014 and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after that date. While every care has been taken in the preparation of this document, AMP Capital Investors Limited makes no representation or warranty as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This document has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided.

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