Seeds of a bull market

Europe’s crisis will continue for some time, but the foundations of a new bull market are being laid.

PORTFOLIO POINT: While the European crisis is unlikely to be resolved in the short term (meaning sharemarket volatility will continue), the seeds of the next bull market are being planted.

During the last week or so, as the sharemarket was falling, a number of people came up to me and said: “Is now the time to get into the market?”

And just to underline the point, I was at the football watching Essendon play Richmond and at half time I was confronted with this very question, instead of the usual discussion point “who is going to win?”.

There are never easy answers to questions like this, but let me put my point of view. Obviously we are in a tough sharemarket created by a banking/currency crisis in Europe and a slowdown in China. At the same time, the American situation is sluggish. Slowdowns and sluggishness are regular hazards that affect sharemarkets, which we are all used to, and don’t affect long-term plans. But a potential breakdown in the global banking system takes us into unchartered territory. It may all end in a long, hard European grind – again, an event we can handle. But the unquantifiable risk of something far worse gives me the jitters. Perhaps it’s my age. But it’s not a risk I have encountered before, except during the global financial crisis, but in that case it was sudden and not a drawn-out risk saga.

I know many people have a different point of view; some suggest we are really in a long-term bull market and this is merely a correction. And on Thursday, you saw an impressive performance by Wall Street, which was down about 1.5% in the wake of bad European numbers but climbed all the way back. Last night, US stocks gained ground, although not as much as Europe. This is typical of a market that really does not know what is ahead.

In a market experiencing such turmoil, a traditional strategy for long-term investors is not to try and pick the bottom of the market – it’s just too hard.

So my advice to the people at the football was to stick with equities, assuming they do have a portion of their money in the sharemarket, but don’t increase your holding at this point.

I have never experienced anything like what I am now seeing in Europe. The European problem is much greater than simply Greece or Spain, given that European banks fund about 80% of global trade. But there is a long-term twist to this whole situation that keeps nagging me, which is why it is also dangerous to be out of equities.

There is a possibility that if Greece leaves the euro, we will see a huge flood of money to prevent or curb the nasty side effects and that, of course, would lead to inflation. That’s what happened in Germany during the 1920s and shares became a key way to protect your capital.

In the current situation, inflation looks to be the least of our problems. Having registered that concern, I still think it is safer to take the normal bear market strategy for long-term investors.

However, I believe the seeds of the next bull market are starting to be planted. One way or another, there will be a crisis in Europe and some form of stability will emerge afterwards (albeit Europe will not be a great market over the next few years). The global deleveraging that goes with this will continue, but it will not last forever.

China can’t afford to have growth rates that are too low. I think that in due course, China will undertake whatever stimulation is required to lift its growth rates.

And I am a long-term American bull, so longer term I am looking to increase my exposure to the land of the stars and stripes. The country has a lot of problems at present and there is not going to be a great deal of joy in the next 12 months, but the American discovery of enormous quantities of gas means it will have low imported energy levels, low energy costs and a very carbon efficient nation. (Next week, Tim Treadgold will look at the US shale gas sector in more detail.)

We are seeing a lot of signs that American manufacturers are beginning to take their activities out of China and put them back into the US. At present, the trend is small, but I think it is going to develop a pace when America cuts its corporate tax rates after the next election and the full extent of this energy bonanza becomes apparent.

As far as Australia is concerned, we as yet have not appreciated the significance of what America has discovered in gas. Almost certainly, that discovery will put a lid on our coal and LNG prices and in my view, will hold back some of the LNG developments that might have taken place later in the decade.

But having said that, as I walk around Australian companies I am seeing an understanding develop that they do need to look more carefully at what they are doing and how they are doing it. And that is going to boost profits in due course.

As I have written on many occasions, it’s been important for people to set their equity percentages at levels that they’re comfortable with – not what some financial planners (not all) dictate. And my view has been that currently, those equity percentages should be at the lower end of that comfort zone. At current levels, we are clearly seeing value in some areas and with interest rates falling, many are looking again at the sharemarket – hence the question at the football. The Kohler strategy, of having a portfolio with 30% in various selected equities and 70% in cash or longer term bank deposits, is a good one.

Many investors and self-funded retirees have a small section of their portfolio devoted to trading where they try and pick the bottom. I know a number of people who buy into the Australian market as the index goes close to 4,000 and sell out when it reaches 4,500. That’s worked but it’s a trading exercise.

My strategy is to come in when we know a lot more about the extent of European risk, even though at that time the stockmarket will be higher. And if you currently want to have a portion of your long-term portfolio in the US, do so – but on the basis of spreading your equity, not on the basis of increasing your equity percentage.

Interestingly, for those who have large amounts of cash, there is a fascinating deposit game being played out among the banks. None of the banks want to be hostage to this dangerous European situation and they want to keep encouraging self-managed funds to place money in bank deposits. And so we are seeing the almost bizarre situation of the leading banks offering 5% for almost all their shorter-term currencies. It’s as though they are frightened that if they drop the interest rate below 5%, they will see a major exodus of money by the self-managed funds.

In this situation, don’t be frightened to look around to some of the smaller banks and place amounts less than $250,000 on deposit, because higher rates are available. However, do not put more than $250,000 on deposit, because you lose your government guarantee.