Unemployment is also rising, yet share markets have been moving higher for the last three months. History indicates time and again that the best gains in stocks are usually made when the economic news is poor and economic recovery is just beginning or not even evident.
While this might work over the long term, it suffers from the same weakness as Myth 7. That is, by the time housing construction is really strong it should already be factored into the share prices for building material and home building stocks. Thus the market may start to anticipate a downturn.
The logic behind this is simple supply and demand. If the Government is borrowing more then this should push up interest rates and vice versa. However, it often does not turn out this way. Periods of rising budget deficits are usually associated with recession and hence weak private sector borrowing, falling inflation and decreasing interest rates. In this case, bond yields actually fall, not rise. This was evident in both the US and Australia during the early 1990s recessions and in Japan through the 1990s. While surging public sector borrowing around the world has contributed to a rise in bond yields this year, reduced ‘safe haven’ demand as investor confidence has stabilised may be the main factor. It remains to be seen how bond yields will behave as the rising level of excess capacity globally puts further downwards pressure on inflation as normally occurs in the aftermath of a recession. History suggests bond yields might head lower again.
This mistake has been clearly evident in recent years. A common strategy has been to build up more diverse portfolios of investments that are less dependent on equities and with greater exposure to alternatives such as hedge funds, commodities, direct property, credit, infrastructure, timber, etc. This generally led to a reduced exposure to truly defensive asset classes like government bonds. In effect, investors have been taking on more risk helped by the ‘comfort’ provided by greater diversification. Yes, there is a case for alternative assets. But unfortunately the events of the last two years have exposed the danger in allowing such an approach to drive an increased exposure to risky assets overall. Apart from government bonds and cash, virtually all assets have felt the blow torch of the global financial crisis, with agricultural investments being the latest victim in Australia.
For many, the motivation to reduce tax is a key investment driver. But there is no point negatively gearing into an investment to get a tax refund if it always makes a loss. Similarly, the recent experience with Managed Investment Schemes also highlights the danger in relying too much on tax considerations to drive investments. The first priority is to make sure that an investment stacks up well in its own right – without relying on tax
considerations.
Economic and investment forecasts are often seen as central to investing. It is well known that when the consensus of experts’ forecasts for key economic or investment indicators are compared to actual outcomes they are often out by a wide margin. This was particularly the case last year. Forecasts for economic and investment indicators are useful but need to be treated with care. Like everyone, market forecasters suffer from numerous psychological biases. Also, quantitative point forecasts are conditional upon information available when the forecast is made and need adjustment as new facts come to light. If forecasting the investment markets was easy then everyone would be rich and would have stopped doing it. The key value in investment experts’ analysis and forecasts is to get a handle on all the issues surrounding an investment market and to understand what the consensus is. Experts are also useful in placing current events in their historical context and this can provide valuable insights for investors in terms of the potential for the market going forward.
This is far more valuable than simple forecasts as to where the ASX200 will be in a year’s time.
The myths cited here might appear logical and consistent with common sense, but they all suffer often fatal flaws which can lead investors into making the wrong decisions. The trick to successful investing is to recognise that markets (and economies) are highly complex, that they don’t go in the same direction indefinitely, that markets are usually forward looking and that avoiding crowds is healthy.
Dr Shane Oliver is head of invsetment strategy and chief economist at AMP Capital Partners.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
