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What's up: A tale of overvalued shares

The Australian share market is sitting at all-time highs at the moment.  Last year the share market rose almost 20%, and it’s increased another 6% in the first few weeks in January.  We’re not alone.  US shares were up around 30% last year as well.

It means that most super fund members enjoyed healthy double digit returns last year, even after fees and taxes.

It’s a lot of fun seeing your super balance go up during boom times.  Especially for recent retirees or people close to retirement.  In the years around retirement you have the most money saved, so the strong investment returns have a magnified impact.  It’s called ‘the portfolio size effect’.

But markets go up and markets go down.  And the portfolio size effect doesn’t just magnify positive returns.  It magnifies investment losses as well.

 

All tip, no iceberg

In 2007 former Prime Minister Paul Keating famously described then Treasurer Peter Costello as ‘all tip and no iceberg’; saying he lacked substance and conviction to act.

And that’s the trouble with this share market boom. It’s all tip, no iceberg.  It isn’t backed by economic fundamentals, lacking in substance and conviction.  

There’s a lot of money pouring into the Australian and US share markets.  It’s because of the record low interest rates.  Poor rates on cash and bonds are forcing conservative investors to search for investment yields elsewhere.  Dividends on shares are currently way more attractive than fixed interest, and that’s pushing conservative investors to invest more of their money into shares. 

When buyers outnumber sellers, prices go up.  

 

A time for caution

But there needs to be more than sentiment driving growth. Companies need to underpin their higher share prices with business performance or share price rises will be short-lived.

And positive sentiment can change quickly, especially in times of uncertainty.  

There’s plenty of uncertainty right now.

Let’s start globally.  The global economy is slowing down.  In 2018, global growth was 3.6%, but last year it dropped to just 2.9%.  Of course, there’s Brexit, with so much confusion around what a post-Brexit trade deal with the European Union might look like for Britain.

There’s the uncertainty that comes from the ongoing US – China trade war; between the largest and second largest economies in the world.  China is already experiencing a slowdown and is currently growing at its lowest rate in three decades.  Australia’s fortunes are linked to China more than any other country.  Around one-third of our exports are shipped to China.

Here in Australia, we’re yet to understand the economic impact of the devastating fires still burning.  These could be wide-ranging.  Of course, there’s the damage to property, with more than a billion dollars of claims already lodged.  There’s the direct impact on industries like tourism and agriculture, but also broader impacts like reduced productivity and lower consumer confidence.  

The London based consultancy Capital Economics has estimated the bushfires could stunt quarterly growth by 1%.  This could push the economy dangerously close to zero growth, or worse, this quarter.

 

What this means for your investments

Contrary to popular opinion, higher share prices make investing riskier, not safer.  And if you’re a retiree, or preparing for retirement, your risks are bigger because you’ve got more money exposed and less time to recover the losses.

As retirees, you need to expose your investments to growth markets, especially during times of positive momentum, but at the same time protect yourself from the inevitable share market busts that follow.

And that’s the conundrum.  At When Financial Solutions we help retirees build investment portfolios that can withstand the short-term hype.  We can help you retain exposure to growth-style assets like shares, so you participate in the good times while protecting your cashflow during the bad times.  

Because it’s not a matter of ‘if’ investment sentiment falls, but ‘when’.

 

Michael Bowman and James McMaster are co-founders of When Financial Solutions

 

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