In this update, MLC’s Senior Investment Specialist John Owen looks at:

• the standout performance of the German market
• the mixed sharemarket results from Asia, and
• what it all means for your MLC investments.

View the View the May market update video here.

Download John Owen John Owen video script.

In this update MLC’s Senior Investment Strategist John Owen looks at:

• factors which influenced the Australian sharemarket
• the solid performance of both Australian and global property, and
• what it all means for your MLC investments.

View the View the February market update video here.

Download John Owen John Owen video script.

• the recent performance of the MLC Australian Share Strategy
• the outperformance of manager Sands Capital, and
• what it means for the MLC Balanced and Growth Funds

View the February MLC Fund Performance Update video here.

Download John Owen video script.

With predictions of a global recession stretching well into 2010, and an assumption that Australia will not be immune, does this mean investors can expect more pain? The answer, it seems, is maybe not.

The world is in one of the most serious economic and financial crises since the 1930s depression. Economies have rapidly contracted, the world’s financial system is in disarray and unemployment queues are lengthening.

In response, governments across the globe are undertaking massive programmes to avoid a repeat of anything like the Great Depression. We’ve seen trillion dollar stimulus packages, government guarantees of banking deposits and lowered interest rates amongst a whole host of other measures in an attempt to stimulate the economy.

In relative terms, Australia has fared well so far. We’ve experienced negative economic growth and a rise in unemployment, but recent developments have been more positive. These include significant gains in share prices, strong retail sales and an unexpected positive increase in the March quarter GDP.

A common assumption is that a grim economic situation naturally extends to the sharemarket. However this is not necessarily the case. The recent recovery we’ve seen from equity markets is a good example of how sharemarket returns can be positive, even in a seemingly gloomy and bearish environment.

If you examine previous recessions an interesting pattern emerges. What we see is that the sharemarket is a discounting mechanism that factors in economic distress before it becomes evident in the wider economic picture. Hence, while a dip in the sharemarket can suggest troubled times ahead, history indicates that a rising sharemarket during a recession often occurs before a bounce in the economy.

Looking in the rear view mirror

It’s interesting to look at how sharemarkets have reacted in US recessions since the 1950s.

Source: Thomson Financial Datastream.

As you can see, returns from equity markets were positive in five out of the nine recessions. Furthermore, if we look at the returns achieved over the three years after the start of the recession, on all but one occasion sharemarket returns were positive.

In the 1990’s the rebound in equity markets occurred before the end of the recession. This is the typical pattern. In fact, in this case the rebound started closer to the start of the recession than the end and the return from US equities over this period was positive.

The recession of the early 1980s lasted longer, but similar conclusions can be drawn. In particular, the recovery in the sharemarket commenced before the recession was officially over.

It pays to be cautious in drawing conclusions from historical returns. We can’t assume a perfect correlation between the period of economic contraction and the period of negative sharemarket returns but history tells us that equity markets tend to lead the real economy.

Recessions and share prices

As I’ve explained, share prices are forward looking and already incorporate what the market expects. This was evident in Australia when the sharemarket fell around 50% from the highs recorded in November 2007 before we even entered a recession. Clearly, a significant part of this decline reflects the pricing in of the (likely) future recession.

Another factor is that investor sentiment is a key driver of market prices. Sentiment can swing very quickly from strongly optimistic to complete panic. This can mean that equity market returns turn sharply negative immediately before and during the early stages of a recession.

The opposite can also occur. As sentiment and confidence improves, equity markets can bounce back very strongly and long before the economic data improves.

Implications for investors

It’s important not to translate what’s happening in the economy directly to sharemarket returns. While clearly economic news will have an impact, what’s more important for returns is what’s already priced in and whether the new information is better or worse than this.

In addition, in this type of environment, commentators and investors often claim to sit on the sidelines and wait for one of two signals before beginning to invest again: strong returns from equity markets and/or better news on the economy.

Unfortunately, waiting for these signals often means you have missed much of the rebound and hence significant returns.

Trying to time the markets like this is a dangerous strategy and can prove very costly. There really is no bell that will signify to investors that it’s OK to jump back into markets.

The historic relationship between recessions and sharemarkets is compelling but not a hard and fast rule. No two recessions will be exactly the same. In the absence of perfect foresight, what can you do? Resist the urge to cringe when an investment ‘expert’ wheels out the mother of all motherhood statements - “focus on the long term”. Like most clichés it exists for a reason; namely that the long term is more predictable than the short term.

View Investing in today’s market here. It contains the following videos:

- Brian Parker, an Investment Strategist at MLC, explains the latest economic developments and, in a separate video, provides his tips for comparing your fund in performance tables.

- Michelle Heinrich, Head of Investment Communications at MLC, looks at the benefits of staying invested in dividend paying shares and explains how, over the long term, this could be an effective way of growing and protecting your money.

Look out for next month’s video series which will include Brian’s update on economic developments at home and abroad, plus analysis on what this year’s Budget means for everyday Australians.

Stay tuned or why not subscribe to updates so you know when new videos are added to the site?

Please note the videos contain general information only. You should talk to your financial adviser to find out what’s most suitable for you.

If you do not have a financial adviser, call MLC on 132 652 and we’d be happy to put you in touch with one.

With this in mind, MLC’s keynote magazine decided to speak to three people who have been through other market meltdowns throughout history.

In this extract, keynote speaks to MLC Senior Investment Specialist, John Owen, about his experience of the 1987 Black Tuesday Crash.

“In 1987 I was head of Australian equities at another major investment firm. The climate leading up to October was very buoyant, very optimistic,” he said. “There were some pretty remarkable results recorded in the lead-up to the crash. I remember apologising to one client for a 45% one year return.”

Mr Owen also remarked on the importance of several initiatives undertaken by the new Labor Government at the time which deregulated Australia’s financial system.

Moves such as the floating of the Australian dollar and the granting of licences to foreign banks helped transform the environment for investors. However, even in this climate there were warning signs that a major market event was on the cards.

The Australian market was awash with companies of varying quality and substance who, in share price terms, were doing well in the speculative market environment.

Gold companies capitalised on the boom in prices and were being valued at dizzying prices before they had even begun to mine. And so-called ’second board’ companies emerged. While too small to feature on the main market boards, they were enthusiastically targeted by investors.

“To some extent we were concerned, but nobody was really certain. There was evidence of lots of speculative activity in the sharemarket at the time,” he said. “For instance, this was the period of the corporate raider and the entrepreneurs; the likes of Christopher Skase’s Qintex and Alan Bond’s Bond Corporation. They were both the predators and the market darlings of the time.”

Black Tuesday

“I remember that day very well,” said Mr Owen. “I was at home, having my breakfast and heard on the radio that the American sharemarket had fallen 30 or 40%. I thought it was a good idea not to have that second piece of toast, and made my way to the office as quick as I could.”

Although the crash is remembered as Black Tuesday in Australia, it was a Monday in New York. While we were blissfully asleep, markets were in freefall in America and Europe.

“The investment team got together before the markets opened and reviewed what had happened overnight in the US and Europe,” said Mr Owen. “From that perspective, we knew we were going to be hammered when the markets opened at 10 am. We waited for the tidal wave to hit us when markets opened. And hit they did. I can’t remember the number, but it was down in the blink of an eye, something like 30 to 35%. It was very sudden, very quick.”

Mr Owen’s team had an objective of raising cash in their diversified portfolios. What they discovered was even in that market of panic and uncertainty, they were still able to trade blue chip shares. By contrast, some of the previous market darlings – the small board companies, the highly leveraged corporate raiders – couldn’t be moved, and in the years that followed, many collapsed.

Baptism by fire

In the weeks and months afterwards, the market remained volatile, hitting its lowest point on 11 November 1987. MLC’s multi-manager process had only been in place since 1985, so the Black Tuesday crash was a mighty test early on in the piece.

“To me, the fact that the MLC approach survived that challenging period and thrived afterwards says a lot about how robust the underlying investment process is,” said Mr Owen. “It’s interesting to note there’s really only around a dozen balanced funds that were around in the mid 1980s that are still here today.”

Mr Owen sees many lessons learned from the events of ‘87 which are particularly vital for investors today.

“The first thing investors have to truly understand is the risks that they are taking. There are two parts to the investment equation: risk and return,” he said. “You have to weigh up both. By all means take on risk, because risk can help you generate good returns. But only take on those risks you understand, that are consistent with your own preferences and suit your objectives.”

Mr Owen also emphasises one of the ‘golden rules of investing’ as a key learning from Black Tuesday.

“We say it often, but it’s so important: it’s time in the market, not market timing,” he said. “You need to give markets time to work their magic. It’s worth pointing out that investors who had been in the Australian market for the three and five years before the ‘87 crash were still well and truly ahead even after the impact of the crash was factored into their returns.”

Finally, Mr Owen believes the power of a realistic, long-term approach should never be underestimated.

“You should never have to apologise for investing carefully. Your friends may at times be enjoying much higher returns than you are, but they are probably taking higher risks than you,” he said. “Risks can be rewarding in good or buoyant circumstances when the economy and the markets are doing well, but they can bite you in unexpected ways in more difficult periods of time.”

Extract taken from keynote, issue 20, 2008

1. Diversification is king. Investors with a well-diversified investment strategy that has been formulated as part of a long-term financial plan should not be unduly concerned with the market’s recent moves. The aim of diversification is to build and protect your wealth by ensuring your investments don’t all move in the same direction at the same time.

2. Risk and return are related. The higher the expected level of return, the higher the risk (or volatility) you need to be willing to accept. Therefore it’s important you have a realistic expectation of what kind of returns are achievable and sustainable over the longer term given your appetite for risk.

3. Don’t bail out early and miss the market recovery. Reacting to market corrections is a dangerous strategy because it often means you miss out on the subsequent rebound. History has numerous examples of sharemarkets tumbling and nervous investors bailing out, only to miss its eventual recovery.

4. Stay loyal to your long-term investment strategy. Sharemarkets generally reflect the broader economic environment, so investors should expect periods of low or negative returns during weaker economic conditions. Any long-term investor will, therefore, experience poor returns at some stage. The reality is though, that history tells us markets bounce back and eventually return to, or even surpass, previous levels.

5. Always check in with your financial adviser. Two of the most important components of a financial plan are:

• an assessment of your long-term financial goals, and
• an assessment of your appetite for risk.

If either of these components has changed, speak to your adviser about your financial plan. If they have not, then it is unlikely that the recent market movements should trigger a change in your strategy.

6. And finally, it’s time in the market – not timing the market – that matters. Investors in shares need to be invested for the longer term. Over shorter time periods (up to a few years) sharemarkets will go up and down and this will affect investment returns. However over the long term there’s a general upward trend in the market. Therefore by staying in the market and not trying to time its peaks and troughs, you can usually grow your investments over the long term.