Investment Happiness

At the moment, the share markets indicate that expectations are too high.

In the US, markets have enjoyed an outstanding run. It has been fuelled by generous support from the Reserve Bank and a technology boom.

This has led to the expectation that double-digit returns will continue. What is the relevance for Australia? Well, if the US market falls, Australia usually falls by around the same amount. 

Investment Happiness equals Expectations minus Reality (IH = E–R). The “Reality” part of this equation is that there is so little room for error now that bad news can easily spook the markets and lead to falls. For example, we recently saw Facebook, Twitter, and Tencent (in China) fall significantly on less positive news. This should now be the expectation, so preparations to counter this need to be in place.

Of course, this needs to be balanced against the fear of missing out on gains in the final stages of the cycle and in the lead up to the falls. Markets can often run strongly before the falls set in, in what is termed a ‘final blowout’.

We are in dangerous territory and could remain there for some time. This is the confusing part. The concerns grow stronger, the longer the positive returns continue. That is the challenge and a question that no-one can answer with any reliability.

Ashley Owen, Director of Third Link Investment Management recently said that “for the current tech boom to continue at the same pace as it has been to date, Apple, Amazon, Facebook, Google, and Microsoft, etc would need to find a new planet, fill it with another seven billion people, and then sell iPhones, apps, and software to them in the next few years!”  This is a sobering thought. It indicates the view that the markets have squeezed out as much as they can from the investment valuations of stocks like these and from the markets in general.

What do you/we need to do? Stress-testing your portfolio is something that I actively do for you. I assess which assets are exposed to the greatest risk and how they are likely to respond. The other area is that you could stress-test by yourself. How will you respond to share market falls of 20%? 30%? Or more?... Take some time to consider this, as we will discuss it further at your future reviews.

The last big market crash began in November 2007 and ended in March 2009. The majority of asset classes (shares, property, and bonds) and investments all suffered. It was an awful period for clients, investors, and even for myself. In fact, I recall saying that “I never want to go through another event like that.” Well here I am again, lining up for the next one. I’m a little worse for wear but a lot wiser.

One change I have made is the inclusion of alternative assets in portfolios. This move is aimed at limiting the losses, ideally by a good margin. In addition, as we get to more extreme share market valuations, I will be looking at adjusting portfolios away from growth assets to more defensive assets. Of course, this also carries the risk of missing out on gains in the final stages of the cycle and in the lead up to the falls.

Investing isn’t easy in the best of times, let alone in a period like we have ahead of us.

It’s important to manage your expectations to properly appreciate the risks. This will help provide a better level of investment happiness.

Feel free to contact us at any time. Our door is always open.