By Tim Hewson
14 November 2008
We truly live in dark times!
Over the course of the past 12 months we have certainly experienced the highest of highs and the felt the impact of the most severe lows.
In between, we have also been subjected to record-breaking volatility across the full breadth of all markets.
It was only eleven months ago that the Australian equities market reached a record high.
Since then, it has suffered a dramatic fall from grace, which culminated in a 41 per cent drop finishing on 'Black Friday' - the second largest free-fall trading day ever recorded.
Then just two days later, the market rallied and registered its largest single trading day gain ever.
In between the extreme highs and lows, short-selling was banned for 30 days in Australia and limited on most of the major global exchanges to reignite confidence in the markets.
A global insecurity crisis
The severity of the current global financial crisis has been likened to the Great Depression, whilst the state of flux currently experienced by the global equity markets have been compared to the stock market crash of 1987.
We have witnessed the implosion of international investment banks, and the globe's most powerful Governments have been forced to nationalise the world's largest financial institutions simply to keep the financial cogs spinning.
Banks are desperate for liquidity, don't trust one another and won't lend to each other. As a response, they have been forced to foreclose on a huge number of mortgages and kick people out of their homes at an alarming rate.
To rescue the banks from the global crisis (which they themselves caused), taxpayers will be forced to fork out trillions of dollars so Governments can in improve liquidity, whilst they also purchase equity in major global financial institutions as part of urgent fiscal rescue measures.
In Australia, inflation has spiked, unemployment is on the way up and building starts have stalled.
Property price growth is flat and consumers are so massively over-leveraged that unwinding the myriad of gluttonous credit could shift the way the world economy operates for 25 plus years.
In the US, homes are selling for as little as $1 and even being given away on a buy-one-get-one free basis, just so that the banks can clear excess inventory off their balance sheets.
It is estimated that Australia had as many as one million households suffering mortgage stress, whilst the RBA increased interest rates, continued its preoccupation with domestic inflation and ignored the very obvious signs of a looming global financial collapse and its affect on Australia.
In fact, the RBA have recently had to quickly back-flip on their monetary policy stance, simply to prevent our economy from falling into a severe recession.
It was not that long ago that oil spiked to a record high of USD$147 a barrel fuelling a global inflation epidemic whilst the Australian dollar almost traded at par with the US dollar. Since then, oil has dropped to below US$75 a barrel and the Australian dollar to under 70 cents.
The US and some European nations are already in the grip of a recession and the UK and many others are likely to join them - if they haven't already.
But wait, there's more to come!
In a recent address to the nation, the Prime Minister recently stated that we had "entered a new and damaging stage in the financial crisis".
Words that were further echoed by the Head of the International Monetary Fund (IMF), who stated that we are on the "brink of systematic financial collapse".
Most notable in both comments is the distinct acceptance of defeat that the situation may have only just started and that worse is yet to come!
The globally synchronised cutting of official interest rates is likely to only be the beginning of many more monetary and fiscal measures required to stabilise the global markets.
Accompanying this is the global introduction of a bank Deposits Guarantee. And whilst this initiative might be designed to provide temporary and short-term relief, it will likely be responsible for ultimately causing more long-term problems than it has been designed to resolve.
According to Lonsec Research, in the twelve months to the end of the September 2008, Australian Equities were down 27.1 per cent, Australian Listed Property lost 41.8 per cent, International Equities (Hedged) fell 18 per cent, and the Australian dollar dropped 9.4 per cent. In contrast, Australian Fixed Interest and Cash were both up 8.4 per cent and 7.7 per cent respectively.
So what does this all mean for investors?
There is no silver bullet, neither is there a great deal of good news or an abundance of safe havens.
Cash returns are likely to decrease as central banks initiate a synchronised cutting frenzy in official interest rates.
And according to most investment professionals, as credit spreads are expected to contract (albeit very slowly), it would appear that most investors have already missed the performance generated by Australian Fixed Interest.
So unless you sold up and moved your entire portfolio to Cash or Fixed Interest prior to August 2007, you'll just have to hang on for the ride.
Survival guide
To survive these volatile times, it's often worth reviewing your investment portfolio to ensure it is still consistent with your objectives, as this will set the tone of any modifications your portfolio may require.
So go back to the fundamentals and determine whether your investment strategy is still relevant.
Know your pain threshold
Your threshold for withstanding market volatility will have certainly been tested over the course of the last 12 months and it will likely get worse.
With the US only recently admitting they are in recession, global equity markets are likely to get significantly more volatile.
Riding out the storm will become increasingly more important, so make sure your portfolio is suitably ready.
Outsourcing
If you have outsourced to investment professionals, it is times like these that you can very easily determine whether they are earning their keep or not.
Also remember that outsourcing purchases expertise and saves you from having to calculate the often difficult and complex investment strategies needed to navigate the global investment markets.
Construction destruction
You can easily over complicate your portfolio by doing too much, so your initial portfolio construction approach is likely to be the key to the success of the portfolio longer-term.
Make sure that your portfolio is still aligned with your original investment strategy and is properly constructed to achieve your investment objective.
This can obviously be challenging during volatile times, but remember, you do have options:
Diversify
Diversification is broadly recognised as the best mechanism to help protect a portfolio from volatility and to also help smooth longer-term returns. In its most simple form, this means dispersing your investments across a variety of different types of investments.
The law of averages
Dollar Cost Averaging (DCA) is also a respected technique for mitigating the effects of volatility, and basically involves making smaller and regular allocations to the same investment over a longer period of time.
Hedging your bets
For investors with global investment allocations, diversifying through hedging should always be a consideration against currency volatility.
Global investing after all may not only have different tax consequences, but may also have implications for the returns generated by your investments based upon moves in the currency of the underlying investments.
Importantly, different currencies will respond differently in changing market environments, so it's best that you ascertain whether you would like to include or avoid currency fluctuations as part of your investment strategy and risk management.
Super
Super is often overlooked, so for investors who don't run their own self managed superannuation fund (SMSF), remember that superannuation is still one of the most tax effective long-term investment options available.
And whilst there might be a significant amount of variety available, avoiding your superannuation on the basis that it is too complex and that it will take care of itself is a rookie error.
After all according to SuperRatings, the difference between a Secure Fund (with a 0 per cent to 19 per cent Equity allocation) and a High Growth Fund (with a 91 per cent - 100 per cent equity allocation) over the course the year ending 31 August 2008 was 15.74 per cent. So get interested!
Most importantly, remember that investing is a long-term exercise. So you need to look beyond the volatility of the current markets and put things into their proper perspective. And if it all gets too hard, seek advice from an investment professional.
Happy investing, hold on tight and enjoy the ride!
