World share markets have been telling us for some time that things are getting tough. It’s now time for the economic impact to be felt as leading world economies move to recession.

It’s worth remembering as economies around the world slow that share markets are leading indicators. You can expect share markets to take off long before it starts to feel better on the street.

Since our last newsletter the world has moved from the greater fear of a failure of the global financial system to the lesser fear of recession and slowing economies. The greater fear appears to have been averted by the intervention of governments and central banks around the world. The credit freeze which essentially resulted in a freezing of bank lending, including lending between banks, appears to be thawing and money is starting to flow again, albeit slowly.

That said, the US Treasury and Federal Reserve have been criticised for changing tack and giving inconsistent messages in their efforts to stabilise the US financial system.
This has been exacerbated by the imminent change of the US presidency which is delaying much needed action in key areas.

So what does this all mean for your investment portfolios and as one client has asked more than once recently “When will this end?” We don’t have the answer to that question but we can offer you some thoughts from two of the greatest investors of our time. Here’s an extract from a statement from Warren Buffett, often referred to as the Oracle of Omaha, published in the New York Times on Oct 17.

‘The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary. So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds….. Why? A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now. Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over…. Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497. You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy. Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts. Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.” I don’t like to opine on the stock market…. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.’

The following is an extract from a statement issued on 3 October by Anthony Bolton who is president, investment, at Fidelity International. His Fidelity Special Situations fund has been the top performer in its sector since its launch in 1979. He was manager of the fund for more than 27 years.

‘We’ve seen the bottom of the abyss. I saw the bear market in the 1970s that many other investors haven’t seen, and I saw early that it was one of the worst bear markets we’ve ever had. Back then, the Bank of England started its lifeboat rescue of many secondary banks, so it’s not the first time there’s been a procedure for the government stepping in and rescuing the banking sector. But, as ever, it’s never quite the same. In the 1970s, it was in some ways very different. The Bank of England was fully in control, and it didn’t have to second-guess what anyone else was doing. I was still very much in the learning mode in the 1970s. But it did make me cynical about people’s ability to get their investment timing right. I remember going to City lunches where each manager would boast about his liquidity: “I’m 40 per cent liquid”, “I’m 50 per cent”, “I’m 70 per cent.” Then it turned on a sixpence! The problem is that everything around you makes you do the opposite. Some investors would buy now, but there is a new dimension: fear that the whole financial system might fail, that this time it may be wrong to buy. I admit I was cautious early. But, for the first time in a couple of years, I’ve started to feel optimistic. In the last two weeks, we have looked into the abyss that you get at the bottom when the system collapses. What markets have done in the past two or three days are all signs of a low, but whether it is the low is hazardous to say. This bear market started in financials, then moved to consumer cyclicals and, in early summer, to industrials. My view was that it wouldn’t be over until it hit commodity stocks. We’ve seen that finally happen. I still feel, when it comes to the upside, that the first in will be the first out: the financials and consumer cyclicals. I’ve also looked at the nature of the bull market. It was unlike the technology, media and communications bull market where valuations were above trend. That didn’t happen in this bull market – earnings were above trend. Earnings have been coming back down to trend. But we have not seen excessive levels of valuation – so it doesn’t have to be a huge bear market. And this bear market is already long in the tooth compared with previous bear markets. It began last summer, so it is 15 months old – that’s long. In the mid-1970s, the bear market was longer, as was the bear market of 1969-71. Now, all the things I like to see for a recovery are in place. My market view comes from the behaviour of investors – sentiment is very bad. I use indicators such as the purchase to sale ratio, the Vix (index of volatility), put-call ratios, advisory sentiment, the advances/declines measure, and hedge funds net long/short ratio. They are all saying people are extremely cautious, which I think is very bullish. In my 30 years in the business, the standard mechanisms have always worked: the heart of the stock market is sentiment flows, and when there are big excesses, you bet against them. When consumer sentiment is very negative, you want to buy it. I would say shares are as cheap as I’ve seen them in my lifetime of managing money, in some sectors – especially consumer cyclicals, such as general retail and media. There’s quite a bit in those prices already discounting recession – more than in previous cycles. So, although I haven’t invested in the market for several years, I put my own money in two weeks ago, and I put some more in on Tuesday – in funds, and more in developed than emerging markets. But it will be a slow process – I’m not looking for a fast recovery. It will be an extended recovery, and the market may go sideways for a time’.

It’s the same message we have been giving for some time now. Hold your quality investments and wait for the market to turn. It may be sooner and quicker than you think.

Andrew Condell

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The past few months have been incredibly difficult for investors as share markets around the world fell sharply due to strains in credit markets, bailouts of large institutions and concerns of the effect of the global economic slowdown.

The action is in response to an increased level of redemption requests which were affecting liquidity levels and is an unintended consequence of the Federal Government’s decision to provide a guarantee on bank deposits. This has created an imbalance which is affecting investments that fall outside the government guarantee.

Leading research house, Lonsec “believes most mortgage managers have a healthy proportion of their lending book (approximately 20-30% or so) maturing within the next 12 months, which will assist in meeting withdrawal requests, though there is no guarantee funds will be sufficient to meet the initial level of requests. Lonsec believes the delaying of withdrawal requests allows some breathing room for managers to develop systems and processes for dealing with the requests in an orderly and equitable fashion.”

The AMP Enhanced Yield fund has slowed redemptions to 12 months. The Australian Unity and Challenger Howard mortgage funds will be opening to redemptions, subject to available liquidity, on a quarterly basis. The APN Property for Income Fund and the APN Property for Income No 2 Fund plan to have a unit holders meeting in the new year to discuss redemptions.

 

With cash rates falling quickly it is expected that investments within these categories will become more competitive as they offer higher yields than bank deposit rates. This differential will widen further with the imposition of a “guarantee fee” by the government on larger bank deposits within the wholesale market from 28 November 2008. This is expected to go some way to bringing balance back into the market and reducing redemption requests to more normal levels.

We have reviewed the above mentioned funds recommended by Financial Keys and we are satisfied that each of the funds is well managed with quality underlying portfolios. Clearly the difficult financial conditions are affecting these non bank deposit assets. Fund managers have taken the decision to amend redemptions to protect existing investors pending the arrival of more settled market conditions. It could be some time before things normalise. In the mean time the funds are continuing to pay income distributions.

Clients planning to make lump sum withdrawals from their accounts, outside ordinary pension or income payments, should contact us. We can assist in assessing where the needed funds can come from and if necessary, prepare redemption requests for the affected funds. As redemptions have been slowed it would be best to advise us as soon as you are aware that additional funds will be needed.

Andrew Condell

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The past few months have been incredibly difficult for investors as share markets around the world fell sharply due to strains in credit markets, bailouts of large institutions and concerns of the effect of the global economic slowdown.

In September, The US government seized control of Freddie Mac and Fannie Mae fearing they may go under. Lehman Brothers filed for bankruptcy due to the credit crunch. Merrill Lynch was sold to the Bank of America in an effort to avoid bankruptcy. American Insurance Group was propped up by a loan from the Federal Reserve. Citigroup received a large government bailout in November.

Governments in the UK, Belgium, Germany, the Netherlands and other European countries, provided support to leading banking and financial institutions in their bid to aid the ailing global financial system. In addition, there have been moves by many governments to guarantee bank deposits. In Australia, the Rudd government guaranteed bank deposits for three years in an effort to boost confidence in the Australian banking system.

Global share markets were hit hard during the past quarter following the various bailouts and bankruptcies of these large financial institutions. Fear was widespread over concern that the actions announced by various governments and central banks would be insufficient to prevent a global recession. Share market volatility reached new heights during the past few months with markets reacting strongly to any news or rumours.

The Australian share market was not immune to the falls experienced overseas. Initially, Australian financial stocks followed their overseas counterparts. In turn, resources stocks began to lose value as a result of the decrease in resource prices in anticipation of lower demand in a slowing global economy.

Economies around the world are clearly slowing as shown in the table below.

 

Growth figures have been revised downwards several times this year. After so many years of strong growth, the threat of inflation is dissipating and there is a rapid slowdown in economic growth in many countries around the world. It appears that the worst affected will be Western Europe, the UK, Japan and the US. China is expected to continue to grow strongly, albeit at a slower pace than last year. Countries such as Canada and Australia have proved quite resilient. They are expected to slow, however continue to have positive economic growth through 2009.

Central banks around the world have been busy during the past few months, cutting interest rates sharply. In Australia, the Reserve Bank of Australia (RBA) has acted strongly, reducing the official interest rate by a total of 2.00% during September, October and November. Further significant rate cuts are expected in December and in 2009.

In addition to the RBA’s rate cuts, the Rudd Federal Government announced a substantial fiscal stimulus package, the majority of which is expected to be delivered prior to Christmas. The government also advised that they are prepared to go into deficit to help stimulate the Australian economy.

Governments around the world have also announced strong fiscal stimulus measures to help revive their economies. China have cut official interest rates sharply. Their economic stimulus package is quite substantial - $870 billion over the next two years. This is to be spent on infrastructure, post-earthquake reconstruction and housing.

Oil reached a peak of US$147 per barrel back in July. By mid November this had fallen to US$50 per barrel on the back of the global economic slowdown which is seeing a reduction in the demand for oil. OPEC’s (Organisation of Petroleum Exporting Companies) decision to cut production to 1.5million barrels a day was not enough to prop up the price of oil.

The Australian Dollar reached a peak of US$0.9549 cents in July. Since then it has fallen sharply reaching US$0.6448 cents by late November. The weakening of the Aussie Dollar can be attributed to a number of factors. The combination of increased global risk aversion, lower commodity prices and large cuts in interest rates each had an effect.

The outlook is for continued share market volatility, as concerns continue about companies’ abilities to withstand the economic slowdown. The strong moves by governments and central banks in doing “whatever it takes” will help stimulate economies and provide much needed confidence. Confidence has been hit hard and it will take time to restore. However, share markets have already fallen a great deal this year, so good quality stocks may now represent good value from a long term perspective.

 

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