Market Update – September 2017

MARKET REPORT

August saw many public companies report their financial performance for the 2016/2017 financial year. Reporting season is always interesting. Company reports are a closely held secret. Nobody who is privy to the contents of a company report is allowed to buy or sell shares in that company prior to the information being released to the market. Nevertheless, often the actual report of a company comes as little surprise to the market. Market surprises are what move share prices.

For example, look at the case of Commonwealth Bank. On 9 August the Commonwealth Bank announced a record profit of $9.9 billion for 2016/2017. The share price rose by only 0.5%. By the end of August, its price had actually fallen by around 4%. Much of this fall was due to the other big news for the month: Commonwealth Bank had been aware of some unlawful money movements by customers, but had failed to act on this information as it ought have.

So, two substantial announcements: the first, announcing a record profit, barely moved the market. The second, announcing a regulatory failure, knocked 4% of the share price. The reason? The second announcement surprised the market (in fact, it even surprised the regulator, but that’s another matter altogether).

When considering why the first announcement did not shock the market, it is worth remembering that the specific information revealed on August 9 was not known to anyone buying or selling shares in the days prior to that release. Australia’s insider trading laws are strict, It is unlikely that anyone who knew the specifics of the Commonwealth Bank’s financial performance traded on that knowledge. So, how did the market seem to know that a was going to be announced?

The answer is simple: really smart people spend their days analysing businesses such as the Commonwealth Bank. These people work for investment managers and institutional investors. They are university trained and have decades of experience in watching companies like the Commonwealth Bank.

Why is this important for individual investors to know? Well, if you want to actively trade shares in public companies, these really smart, wellinformed people form ‘the other side’ of the trade. If you buy shares, people like this are probably selling them. If you are selling, vice versa. When you buy and sell shares you don’t typically know who you are trading with. But there is a very good chance that you are trading with an expert. Studies consistently show that about 80% of shares listed on the ASX are held by institutions and foreign investors (typically institutions). So, if you are trading, there is an 80% chance that you are trading with an institution.

So, ask yourself a simple question: do I know better than the institution to whom I’m probably selling or from whom I am probably buying? Probably not!

That said, there are two broad reasons that you might be buying shares. One is to hold over the long term, in the pursuit of a regular dividend stream and/or a capital gain. The second is to hold over a shorter term, in which case you are making a bet that the current price is low and will rise after you purchase the share.

If you’re in this first boat, then it does not matter that you are probably trading with an institution. By taking a long-term timeframe, you are not trying to time the market. This is smart investing, because for you to time the market well means that the other trader (the institution) needs to be timing the market badly.

But if you’re in the second boat, you need to be careful. As we say, the person that you are trading with is probably better educated and more experienced in the market than you. They spend all day every day looking at the financial performance of companies such as the one you are trading. It is no shock to them when a company such as Commonwealth Bank returns a record profit of just under $10 billion for a single financial year.

When it comes to successful sharemarket investing, it pays to ‘know what you don’t know.’ Buying a diversified portfolio and holding it over time is a great way for most investors to proceed.

If you want to own specific shares, then taking advice from a market expert also levels the playing field. It always pays to know what you do not know.

The Property Market

This month, we going to take a quick look at the outlook for interest rates. As you may know, interest rates are heavily influenced by decisions from the board of the Reserve Bank of Australia. The board meets on the first Tuesday of each month to discuss whether it will enter the market to influence the general situation for interest rates. Any changes are announced later that day. As a general proposition, if the board decides to enter the market so as to increase interest rates, then interest rates payable on property loans tend to increase by a similar proportion.

A few days after their meeting, the board releases a summary of its thinking. It provides a quick summary of the main economic data to which it pays attention. In August, the board stated that its forecast for the Australian economy are largely unchanged. It expects the economy to grow at a rate of around 3% per year for the next two years. Current inflation is just below 2%, although the bank expects that this will grow slowly following its forecast economic growth. In particular, rising electricity prices are expected to cause an increase in the official inflation rate, although new entrants in the retail market (hello Amazon) can be expected to drag the prices down.

interestingly, this is what the bank has to say regarding housing:

“Conditions in the housing market vary considerably around the country. Housing prices have been rising briskly in some markets, although there are some signs that these conditions are starting to ease. In some other markets, prices are declining. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years. Rent increases remain low in most cities. Investors in residential property are facing higher interest rates. There has also been some tightening of credit conditions following recent supervisory measures to address the risks associated with high and rising levels of household indebtedness. Growth in housing debt has been outpacing the slow growth in household incomes.”

This last line is important. Housing debt is growing faster than household incomes, meaning that households are becoming more vulnerable to things like increased interest rates. Happily, the RBA considers that interest rates do not need to be adjusted at this time.

But this might not always be the case. Historically, current interest rates are low. Conventional wisdom holds that the thing to do at this time is to reduce net debt. You can do this by either paying down debt, or acquiring new investment assets (or both).

One thing you shouldn’t do is simply spend the money you are saving. The best way to strengthen your ability to cope with increased interest rates is to assume that the increase has already happened. For example, if you are paying 4% on a $300,000 loan, then you might adjust your repayments so that you are repaying an amount that would be required if interest rates increase to 4.5%. In this way, if interest rates increase you won’t experience a shock. Even better, you won’t have developed a dependency on spending a higher amount of money.

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