The $64,000 Question: is the global economy healthy? Should you invest in vibrant business and its financial lifeline, the share market, or “hide” in safe, Fixed Interest bonds and Cash?
The Standard & Poor’s 500 (S&P 500), is the “gold standard”, stock market benchmark based on the market capitalisation, or value, of the 500 largest, U.S. companies.
It is thus a pretty good proxy for the health of the U.S. economy, which, in turn, means the health of the global economy.
It looks like the global share market is at a pivotal point.
Investor sentiment can continue optimistically lapping up Central Bank, credit stimulus or could potentially collapse into a “correction” phase defined by its more “realistic”, long term value. Share prices can hold at current, remarkable, and perhaps inflated, highs or crash, by up to a half to align with longer term norms.
So, if you are an optimist you should invest in shares, or, if you err on the pessimist, maybe going for a lower risk, but lower benefit, fixed interest portfolio would be more appropriate for you.
The Good News Story
The Share Market is back to historical highs
Long term analysis by fundamental quants may suggest that the share price bubble is virtually endless. Some economists are pretty bullish and optimistic. They suggest it is not a time to sell out your position, but there’s a healthy, growth period ahead of us. At worst, we are in a period of consolidation. Whereby, there has been 15 years of “bust” cycle volatility, but we are near the end of this and the boom cycle is about to begin again. This 20 year, boom and bust cycle is well documented. The Bust, which started with the DOT.com bubble bursting in 2000, is essentially winding up. The Boom will now continue the century long progression upwards. This is an intrinsic and fully intended progression designed into our Western, fractional reserve banking model. Our money supply expands upwards exponentially ad infinitum. Hold tight and the ride upwards will recommence, in a just few years, and with vigour.
This standpoint is bolstered by Elliot Wave, behavioural theory which, when applied to the share market, suggests that when the end of Wave III (our current bubble since the GFC) is reached then we can expect a minor price slip (red forecast line – Wave IV) for a short while before a Wave V thrust onwards and upwards.
Many, including myself, predicted a double dip recession with the onset of Ben Bernanke inspired Quantitative Easing. In never, and will never seemingly, happen.
The Bad News Story
The Emperor has no clothes
When share trading volume and buy-sell, price spreads contract, even as stock prices surge, it’s a warning sign. This market stagnation signals the traders surreptitious shuffle to the trade room exit door. This phenomenon has preceded sizeable price crashes in the past. Be wary. In addition, the S&P 500 (importantly, in inflation-adjusted terms) is nearly as high today as it was at the heady heights of the ill-fated booms of 2000 and 2007. The market has clambered back to the heady heights of these two prior, relatively recent peaks. Is it third time lucky? Can the market push prices, in other words its evaluation of global business and productivity, beyond where it ceilinged in 2000? The highs of 2000 and 2007 lead to rapid crashes. These were corrections. Leading up to these crashes, investor bullish sentiment pushed prices higher and higher. This was gambling behaviour. This was not “Warren Buffet” style, value investing whereby the underlying value is core to your perception of share value. This was speculation and greed at work. I don’t say this in a cynical condeming way. It’s exciting to speculate and to let constraining rationality fly our the window. This defines as humans – opportunistic.
Well, we’re back there again. Once more, we have bubbled the share market. The global market is in a pivotal position. Does the past few years of Central Bank lead, Quantitative Easing, a somewhat farcical euphemism for money printing, placate the market’s jittery confidence? Do we believe the Emperor does indeed have invisible clothes? Does this printed money have real value we can trade with? Can we expand the money supply and use it to pay off our existing debts?
The share market is a reflection of underlying, economic productivity and the value thereof. It is subjective and filled with investor sentiment. But it is fundamentally driven by the real value we collectively assign to mankind’s productivity. We are currently over-pricing this underlying value (compared to a century of 1.75% compound growth). Perhaps, that’s why the share price is hitting a price ceiling again. The speculator’s bluff is, and always will be, finally, at some point, called. Ever since the famous “Tulip Mania” of 1600′s Holland, we have seen markets bubble then finally some “child” in the cheering crowd will shout, “but the Emperor has no clothes”, and the bubble bursts.
A century of share prices (S&P 500 – Inflation adjusted)
NB semi-log scale to equalize vertical distances for the same percentage change regardless of the index price range.
The peak in the 2000 marked an unprecedented 150% overshooting of “real” market value (nearly double the overshoot seen in the Great Depression of 1929 no less). The share prices of the S&P 500 companies should be sitting around on the long term regression value. They should be averaging around 1000. However, they currently tip over 2000. This is over-valuation. Over valuation enabled by ease money produced through Quantitative Easing. This situation is gagging for “correction”. A price reversion or normalisation, or crash if you will, is threatening the safety of the empire on its borders.So, should one stick with these over-priced, but nevertheless currently stable and profitable, shares, or should one “hide” in low risk, but low return, fixed interest bonds and Cash?
Your Options for investing in your future
I have been putting my faith in the “Growth”, Sunsuper, superannuation investment strategy. Last night I decided to jump out of this share-based strategy and retreated into the Fixed Interest-based, “Conservative” strategy. Here’s the 2 mutually exclusive alternatives:
Has a strong emphasis on global shares, which are sensitive to global fundamental drivers and thus can be very volatile on an annual basis:
Has a strong emphasis on Fixed returns provided by long-term, Fixed Interest bonds and short-term, Cash deposits. These “safe” investments have low volatility that equates to less than 1 out of 20 years of negative returns:
Comparing the performance of the past 5 years of both strategies, one could infer that another bumper share market year, like our current one, would benefit you 8% if you were in a “Growth” strategy. This 8% is the difference between the rates of annual return of the “Growth” (16.2%) and “Conservative” (8.4%) strategies. However, if the share market reverts to its, some say, “rightful” long-term position, there is a 50% downside crash from a S&P 500 index of $2000 to $1000.
Is the market going to bubble forever with endless Quantitative Easing Credit? Or, will this money printing scheme have a comeuppance and the historical real value of shares be restored? If you believe that Central Banks, primarily the U.S.’s Federal Reserve, can Quantitatively Ease our way out of recession, then stick with shares. Hiding your wealth in Fixed interest Cash and Bonds will cost you 8% in lost opportunity compared to this. However, if believe that the Ben Bernanke model of global recovery is likely to fail in the coming year, going for a low risk, Fixed Interest strategy represents a potential 50% portfolio gain.
The probability of either happening is pretty much 50:50 at best. No one really knows what the near future lies in hold for us. Economists will bet their bottom dollar on an optimistic recovery or, alternatively, a pessimistic reversion to century long growth rates. Who’s to say who’s going to be right? However, the potential cost of incorrectly investing in high risk shares is much higher than the cost of investing in Fixed Interest products. In my (un)humble opinion, using a cost-benefit analytical approach, a “Conservative” investment strategy is the way to go. Playing the probabilities is the betting man’s play.