From Daily Reckoning (Australia)-
Dow steady. Gold steady. Aussie dollar steady. Capital city auction clearance rates steady. Interest rates steady.
To borrow from yachting terminology, markets are becalmed.
There is no wind in the market’s sails.
Depending on which weather report you believe — either favourable winds will soon pick up and markets will continue progressing at a steady rate of knots, or the perfect storm is brewing and markets are going to capsize.
During the week, Future Fund Chairman (and former Treasurer) Peter Costello issued his own weather warning (emphasis mine):
‘Looking forward the investment environment is challenging with returns likely to be lower and risk higher… With this outlook it is prudent to hold the level of risk in the portfolio at a lower level than would normally be the case.’
In battening down the hatches, to account for the expected choppy conditions, the Future Fund now holds nearly one third of its assets in cash and debt securities. This is prudent.
Yet, according to The Australian: ‘The Future Fund has put forward a request to lower its growth target for the next 10 years in an environment of deeply depressed 10- and 30-year bond yields and is still waiting on the government to respond.’
Having to ask the government for permission to lower future growth rates is a waste of time.
Who on Earth (or heaven, for that matter) has preordained government officials with the ability to pluck a return out of the air as a target?
Government agencies (not just in Australia) have an appalling record in forecasting.
The Treasury’s rose-coloured forecasts emboldened our tin-starred former Treasurer, Wayne Swan, to make bold declarations of budget surpluses lurking just around the corner. Look how well that turned out.
Growth targets and forecasts are not worth the paper they’re written on.
Markets do what they do in their own sweet time — irrespective of what some boffin, housed in a Canberra-bubble, thinks they should be delivering.
What happens if there’s a repeat of the 1930s and global share markets crash 80% in value?
What’s a government target rate of 7% worth in that case? Sweet nothing.
What you want, and what markets are prepared to give you, are two very different propositions.
Failure to appreciate this reality is why investors get burned time and time again.
At present, investors (the world over) are chasing yield because they’ve calculated they need X% on their capital to achieve a desired outcome. While the world is in steady-as-she-goes mode, getting X% appears to be a safe bet. Wrong!!!
One of those higher-yielding investments, attracting plenty of investor interest (pun intended), is the bank hybrid security.
Does every hybrid investor know the risk attached to that higher return?
I doubt it.
The Australian Financial Review published an article on 31 August 2016, titled ‘APRA warns on bank hybrid conversion risk’.
Here’s an extract:
‘The chairman of the banking regulator [APRA] has warned investors in bank hybrids to be aware they are more risky compared to bonds or deposits given the securities serve as a “first line of defence” when the regulator manages a banking crisis.’
The ‘first line of defence’ means that, should APRA need to invoke bail-in provisions, investors in hybrids are going to be the first to do (all or some) of their dough.
‘But, but, but that’s not fair’…I can hear yield-seeking investors saying. Wake up. Markets are not about being fair and reasonable. Markets are brutal, unkind, destructive, unforgiving…just like a wild ocean.
The problem is we (as in society) have been led to believe the Fed, the IMF or some Canberra-bound government officials can control markets so they’ll behave in a relatively calm and orderly fashion…delivering preordained outcomes to keep things ‘steady’.
This thinking aligns with the ‘every kid gets a prize’ psychology the nanny-state is all in favour of.
However, markets, like oceans, cannot be fully controlled or tamed by man.
This is a lesson markets are going to deliver — in devastating fashion — at a time of their choosing.
Peter Costello’s caution in stating ‘returns likely to be lower and risk higher’ is at odds with the investment industry’s marketing efforts.
A TV ad, for a large industry super fund, declared (and the difference in font sizes is not a publishing error):
9.16% over the last 32 years to 30 June 2016.
Past performance is not a reliable indicator of future performance.
Both statements are accurate.
The super fund’s growth option has delivered 9.16% per annum since 1984.
Meanwhile, past performance is most definitely not a reliable indicator of what investors can expect to receive in the future.
Which of these factual statements do you think would have captured the most attention from investors?
No prizes for guessing the 9.16% is more likely to have made viewers sit up and take interest…especially in a low interest world.
Several years ago, I was in a meeting with the CEO of a major investment institution. I quizzed him on why the company’s marketing efforts focused so heavily on publicising the fund’s impressive past performance — especially when we both knew the future is not necessarily going to be a repeat of the past. His reply was straightforward and unashamedly honest: ‘Past performance sells.’
The conditions that created the 9.16% per annum return over the past 32 years — the All Ords rising from 500 points to 5500 points, interest rates falling from 18% to 1.5%, median property values increasing 15-fold, the greatest credit binge in history, boomers in the peak consumption phase of their lives, China’s massive economic transformation — are unlikely to be repeated (to the same extent) in the coming years.
What we may find is that the excesses which led to markets delivering returns far superior to any other period in history are actually going to be their undoing.
The Depressing 1930s were nothing like the Roaring 20s.
While markets are becalmed, it would be prudent to take a leaf out of the Future Fund’s strategy and reduce the risk in your portfolio.
Accept a lower return for a higher level of security.
Sometimes, staying put in a safe harbour is far better than risking life and limb on the high seas.