Finance

What does the global financial crisis mean for you?

^{APRIL / MAY 2009}

Two financial experts analyse the current economic climate and what impact it could have on the over 50s. They look at shares, property, super and other investments in the year ahead.

Bond University Assistant Professor of Finance Simone Kelly

Some commentators believe we will come out of the current world recession in the next few months while the more pessimistic believe it will take the next several years. There are still some international issues working there way through the system. The credit crisis for the former Russia satellite states of Eastern Europe are putting extreme pressure on the Euro and may unravel the European economic union. Counter-balancing this is the massive stimulus package put forth by the Chinese government with its positive implications for the Australia resource sector. What impact does this global financial crisis have on the near future for Australian retirees?

For holders of some asset classes like fixed income there is the positive impact of lower interest rates on borrowed funds. This is unlikely to benefit the bulk of retirees for whom the extent of debt in their portfolios will be limited. The negative side of lower interest rates will be that low risk fixed income investments are expected to yield extremely low earnings. Prospects for the property sector for the next 12 months are mixed. The lower and upper ends of the property market are somewhat resistant to downturns in the market. In an environment where we are likely to see an upsurge in unemployment there may be a surplus of mid-level properties coming on to the market. This will put pressure on rental returns over the next 12 months.

Equity markets are affected by two factors, capitalisation rates and earnings. Capitalisation rates are a function of interest rates and are likely to rise with reductions in interest rates, meaning the value of stocks should increase. However, it is the earnings side of the equation where extreme uncertainty exists. The only bright spots on the equity horizon is the Australian banking industry where the almost monopolistic dominance of the big four banks will allow them to buttress their bad debt position with increased fees and charges. A second and longer-term opportunity exists in the energy sector, where security prices are directly related to world energy prices. The 60 per cent decline observed in the oil price has resulted in a similar decline in the value of most energy companies. If we can expect oil prices to increase back to around $US80 a barrel (which is the benchmark the energy majors use when budgeting for longer term investments) this may provide an opportunity to realise capital gains in around 18 months.

Self-funded retirees who have heavily invested in super funds which invest primarily in the property, fixed interest and equity markets have seen their investments decline by more than 50 per cent since the highs of late 2007. This suggests a dismal outcome for the coming year. This is especially true for those in managed funds where many of the funds favoured by retirees, such as mortgage trusts and unlisted property trusts, have frozen redemptions to their investors though they continue to make distributions.

The self-managed super fund that has or can accumulate reasonable cash reserves will be able to take advantage of the declining property prices to invest in rental properties that will provide a fair return. Anecdotal evidence suggests that a number of recent retirees are now reviewing their situations with a view to returning to the workforce where others a considering postponing retirement. Those long retired may have less choice and will have to settle on lower pension payments than previously planned.

The reduction in asset values and incomes stream of retirees mean many may now fall below the asset and income thresholds and be eligible for a part age pension at least. The government has cut in half the minimum amount of capital that retirees have to withdraw from their account-based pensions. The good news is this significantly increases the number of self-funded retirees that may now benefit from a partial or full government pension.

RMIT University Adjunct Professor Financial Planning Wes McMaster

For those still working, an immediate issue is security of employment. We will see business continue to contract and therefore further job losses are inevitable. The ideal situation is to continue working if possible so that you can recover the losses that will have accrued in your investment portfolio.

For those people with cash, this period of decline in values delivers a classic opportunity to buy assets at low prices. I am not just alluding to listed companies. Cars, boats, beach houses, land, businesses - all kinds of assets will be available at good prices since demand has dropped.

In calendar year 2008 the All Ordinaries index of the Australian share market fell by 41.4%. In the first two months of this year it fell by a further 9.9%. We do not know how far down it will go but history tells us that it will eventually recover. The share market is interesting because it reflects the expectations of the people who make the market. We had heavy falls in the market last October and November and this was the market pricing in an expectation of recession in this year. Now we are having further falls as the market is pricing in expectations of profit declines that will be deeper than first thought.

Because markets are forward looking, they fall before the physical economy falls but they also recover before the economy begins to climb out of a slump. They look across the valley and start to see the pick up in profits a year or two ahead. For this reason markets often start to rise even while the headlines are full of profit downgrades, redundancies and corporate failures. Ironically, it is the very failure of many businesses that allows competitors to pick up market share and emerge from a downturn stronger than ever.

No one can ever pick the bottom of the market cycle and it always seems ‘darkest before the dawn’. It takes a great deal of courage to invest when shares are at their cheapest valuations. Rather than trying to time markets, a strategy of agreeing on a certain percentage of your portfolio always being maintained in shares, property and fixed interest and systematically rebalancing is a far superior strategy. This allows you to consistently buy more of an asset class when it is low and to reduce it when it is high. It takes the emotion out of the process.

It is worthwhile to look back over history and to reflect on all the other periods when the share market achieved a negative result over the course of a calendar year.

Year ended	S&P/ASX 200 Acc
	%
Dec 82	-14.86
Dec 83	66.81
Dec 84	-2.24
Dec 85	44.07
Dec 87	-7.83
Dec 88	17.88
Dec 90	-17.51
Dec 91	34.26
Dec 94	-8.76
Dec 95	21.11
Dec 02	-8.79
Dec 03	14.64
Dec 08	-41.30
Dec 09	?

The interesting point in looking at such data is to look at what happened in the years following a negative outcome on the share market. The table shows that the Australian share market has had six negative years in the past 26 years (excluding 2008). On each occasion, the following year has more than compensated with a strong positive return. The years 1981 and 1982 were the most recent examples where we had two negative years in a row. These were followed up by 66.8% return in 1983, a slight negative return of -2.2% in 1984 but then 44% in 1985 and 52% in 1986.

The key lies in staying the course and remembering Warren Buffet’s adage to “be greedy when others are fearful and fearful when others are greedy”. To be transferring to cash at this stage of the market cycle after falls of over 40% seems to be a pretty illogical thing to do. Wherever the market goes in the next six months or so is not nearly as important as where it is going in the next six years.

Adj Prof Wes McMaster specialises in financial advice and the analysis of risk and return in investment portfolios. He acknowledges the input of the Money Managers Group in this article. If you want to know more about investment risk and return, go to www.wesmcmaster.com.