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Portfolio construction in times of crisis - What now. What next?



There has been a lot of media attention over the share market this week which has increased the number of calls and emails I have received.

Hopefully this memo will address any queries you may have had over the week but have not yet had the chance to discuss with me or your adviser.     I’ll start with what happened, and end with impacts on your portfolio and what to do next.



 

What happened?

Share prices fell dramatically.

 

Why did the share prices fall so quickly?

The US markets fell quickly, and the AU markets followed.

 

What made the US markets drop?

With the share market there is never just one reason, so we’ll point to a few reasons:

  1. US Interest rates are rising
  2. US markets have been running hot for two years
  3. Stop losses

 

Why do these reasons matter?

The world economy is an intricate web of indirect and obtuse causes and effects.

 

For simplicity we’ll be very general:

 

  1. US interest rates rising
    1. International interest rates have been ‘lower for longer’ (just look at your mortgage or term deposit rates).
    2. US have been talking about rising interest rates for years – we all knew it was coming with as much warning as the Australian public all had for the 2000 Sydney Olympic games – this was no surprise.
    3. Last week the US said the interest rates might rise sooner than previous discussions, this was apparently a surprise, to some
    4. Those extremely sensitive to interest rate movements were caught by surprise and the US markets sold off shares
  2. US markets have been running hot for years
    1. The US markets have been going up since 2009, almost in a straight line (in comparison, the AU market has been left behind).
    2. The US markets are up +72% over last 24 months (AU +28% over the same time)
    3. Only three times in the last century has the US market run this far this fast, or ‘hot’ (1929, 1937 and 1987)
    4. Leading companies in the US are trading on 200x PE (AU market long term averages are between 15 and 17x PE)
    5. On Tuesday I conducted an interview cover more details on these movements with slides of charts can be seen here
  3. Stop Losses
    1. Stop losses can be automated sell orders investors have over their portfolios. For example “sell my BHP shares if BHP trades below $30 a share”
    2. Stop losses can have a snow-ball impact on markets; a small snow ball at the top of the mountain can gather more snow and speed along the way down. By the bottom of the mountain the small snow ball can grow into an avalanche.
    3. Snow balls are one small part of the volatility scenario and a simple example to illustrate. Understand there are many, many more aspects to the volatility in markets.

 

Why does this impact the Australian share market?

The US market is the world’s largest economy and a signal for investor confidence world-wide. The AU market is but only a small part of that world economy.

For the extent that the AU market is impacted by the US market we all remember what happened in 2007-2009. If you’d like a refresher rent the movie ‘The Big Short’ and just talk to and AU investor over that period.

One example of the US markets impact the AU shares is that the owner of Coles Supermarkets and Bunnings Hardware (Wesfarmers WES.ASX) announced their financial statements for the last six months this week. In response to these numbers, the WES share price fell -8% over two days. Arguably this was much more than the announcement and numbers justified, but the overall investor sentiment was negative from the US markets. For more details on WES listen to this interview I conducted earlier in the week:

 

What impacts does this have on my share portfolio?

The answer is ‘everything and nothing’.

Everything because all of the points discussed above are considered when recommending your portfolios.

 

Nothing because the portfolios are created to withstand movements just like this, because:

  1. The portfolios are sufficiently diversified – not overly dependent (or ‘weighted’) into any one area;
  2. The portfolios hold baskets of shares (where possible) to gain the exposures to areas of the AU and world economy we desire. In other words, if one company performs terribly the poor performance are very unlikely to have much impact on our portfolios.
  3. Over the last two years we have intentionally kept exposure to infrastructure and listed property below our long-term amounts. This has worked in our favour this week because these two areas of the AU market were hit the hardest. Our portfolio approach is working in a way it was designed to (note – we still want markets in general to go up).

 

What to do next?:

Nothing immediately.

 

Our portfolios are looking for market movements and trends that normally last nine months to a few years.

This weeks’ movements will not change a trend immediately. 

Throughout market turmoil like this there are always new market leaders identified. This week’s movements will provide the ideal foundations we want to identify our next themes to invest. This themes are identified through a process we call ‘rising from the ashes’ – new market leaders rise from the turmoil like the bright-green grass shoots after a bushfire in the outback.

 

Other Articles written for clients:

We often get similar questions from different clients and aim to answer them for all clients to benefit.

 

Here are the recent articles written to address your questions, our clients:


You can find additional insights in our talking stock and portfolio series (Refer links below) 


Portfolio Series:  https://boardroom.media/search/3/portfolio%20Series

Talking Stock series:  https://boardroom.media/search/3/Talking%20Stock

 

If you would like to discuss the above in more detail please contact me directly, or your personal adviser if you prefer.

Authored by 

Christopher Hall

Market Strategist 

Arrow Securities Group

Direct:   02 8006 7573      

AFSL: 448218

E-mail:   [email protected]