Coping with the Great Volatility

The buy and hold era is over for stocks.

We are grinding through the fifth year of the secular bear stock market that began with the popping in late 2007 of the bubble in Australian stocks from 2003.

For investors, what makes this period different from the last is the order in how you ask your questions.

Instead of first wondering what stocks should I buy? The first question should be how much of my portfolio should be in stocks?

Instead of asking what sort of return do I want? You need to ask can you stand volatility and have the time and energy to closely watch the market?

In other words, are you after capital gains or yield?

Because if you want the latter you need to be able to stand high volatility, and if you want the former you have to consider your timing, understand the macro scene and consider risk first, not return.

This market is called The Great Volatility for a reason.

Who wins

You will find that taking the macro approach, and thinking laterally about risk will make your job of finding the individual stocks a lot easier, particularly when you consider sectors from the view of “is this for yield or capital gain.”

For example, given the deleveraging trend of reluctant Australian consumers and the strength of the Australian dollar, retailers are unlikely to do well on capital gains.

The dividend yield is enticing, however.

Myer (ASX: MYR) is currently trading at 18 per cent fully franked, with David Jones (ASX: DJS) not far behind at 15 per cent, grossed up.

But you have to consider that these are trailing yields – we just don’t know what next year’s dividend will be – will they have to retain more of their profits to reinvent their business model due to their lack of innovation, high rental costs and poor customer service?

Will continued falls in share prices wipe out any return on this spectacular yield?

Or will current negative sentiment reverse on continued easing by the RBA cutting the cash rate? These are factors you cannot work out alone with straight fundamental analysis.

Sentimental issues

Another example of negative sentiment outweighing a good valuation can be seen with mining stocks, the ASX200’s second-worst sector over the year (the other being gold stocks).

Even though most domestic institutional investors are overweight the big mining companies like BHP Billiton (ASX:BHP) and Rio Tinto (ASX:RIO) they are falling in price because commodity prices are being pushed down by fears of a “hard landing” in China.

(Some of those fears abated with last year’s June quarter GDP figures from the Middle Kingdom.)

Think sideways here and instead of looking at companies reliant upon commodity prices, look at companies that provide services to those miners, like Monadelphous (ASX:MND) or Lycopodium (ASX:LYL).

Both of these not only offer good yields (7 per cent and 6.5 per cent respectively) but their estimates of value are also growing over the next 2 years as the mining capex boom rolls on.

Another sector that used to offer capital gains, but now is the standout in yield are banks. When the credit boom took hold, Australian bank share prices took off, but have now not moved (apart from enormous volatility, which underlies their non-robust business model) for over five years.

And this is likely to be the course for the next five years, as even though earnings growth is likely to be a positive 2-3 per cent for the foreseeable future, increasing risk to banks balance sheets, either from falling house prices or stricter regulatory requirements, could see more earnings retained and lower dividend payout as a result.

Where are the capital gains then? The macro approach can also provide you with positive ideas, and its healthcare where this can pay off. An ageing population that holds voting power so governments increase health care provisions (e.g healthcare costs rose 6 per cent last year according to the consumer price index) along with advancing medical technology are the drivers behind companies like CSL, Sonic Healthcare (ASX: SHL) and Ansell (ASX: ANN).

Analysts and investors may spend a lot of time analysing individual stocks, but the real money is made in working out the macro trends and drivers to properly allocate your portfolio whilst always focusing on the risk to your investment, not just the return.

Twitter: Chris Becker. Chris Becker is an Investment Strategist at Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

 

Comments

  1. Chris
    You raise a very important issue regarding voting blocs. The ageing of our nation is unprecedented and we must endeavour to include our youth as much as possible in the solutions to the challenges ahead.

    I can see no reason why any tax payer (16 years or above) does not have the voluntary right to vote. I can also not see why any of the 4308 people above the age of 100, who can not tell the difference between an apple and a book, get the right to vote.

    The macro political environment is paramount to understanding future market opportunities. I think it is very likely that as our nation ages, conservatism will grow and that we are likely to have 20 years at least, of conservative governments. Our emigration, already peaking, will be ignored or dismissed out of hand by the govt.

    Recently on a FB conversation as part of QandA, I asked Minister Bowen…

    “Dear Minister, what are your thoughts about our peaking emigration?”

    Chris Bowen replied to demografix/willy nilly…
    “I think one of Australia’s great assets is our diaspora of Australians around the world. In almost every country I have visited as Minister you find Australians working in senior roles and they are great ambassadors and facilitators of trade. Many people will return after a few years overseas (as thousands have in recent years due to the comparative strength of our economy).”

    I fail to see why people would return to a high cost of living as their motivation for a return to OZ?

    • Tis why I’m bullish long term on agriculture (check out the median age of a farmer) and health care stocks (we may see the rescinding of negative gearing in our lifetime, but we wont see the reduction in real spending on healthcare by government).

      • We may not see a reduction in real spending on healthcare, we will see a dramatic increase. That is why policy like aging in-place are growing in momentum. It is cheaper than aged facilities. Problem is people who live alone, get sick more….

        http://www.abs.gov.au/ausstats/[email protected]/Lookup/by%20Subject/1301.0~2012~Main%20Features~Housing%20Utilisation~128

        24.47% of all homes are lone occupants and 53.7% of them with 3 or more bedrooms. 1,103,800 homes as lone occupants with 3 or more bedrooms now. Shocking!
        “87% of lone person households were living in dwellings with two or more bedrooms” is the actual quote from the ABS.
        In God we trust, all others must bring data.

      • Jumping jack flash

        There is also a stigma associated with aged care facilities. Remember that most of the current crop of retirees were at their TV viewing peak when all those 60 Minutes segments about nursing homes were being aired…

    • >I fail to see why people would return to a high cost of living as their motivation for a return to OZ?

      and the lifestyle things which may attract one back are rapidly being trampled too. We’ll probably go back to Europe (something I never thought of when I was growing up in Queensland)

      • drsmithyMEMBER

        and the lifestyle things which may attract one back are rapidly being trampled too. We’ll probably go back to Europe (something I never thought of when I was growing up in Queensland)

        Indeed. Our ~5 year (sooner if the Libs get back in with any sort of majority) plan is to move back to Switzerland or, if absolutely necessary, the UK or America.

          • Some of it was mainstream eg, go mining services rather than the miners – pretty much the standard advice from all an sundry. Actually the article sounded very like the fare from portfolio managers and stock analysts encountered on Sky Business. Perhaps I missed something.

            Didn’t sound like you HnH – “as the mining capex boom rolls on”…

            Cheers.

          • Thanks for the very kind words minebot

            What you missed was again, nuance – that is, the difference between investors chasing capital gains – and hence they need to time their entry and exit into a macro dominated market and those chasing yield, who need to ride the wave of volatility that entails to keep their dividend over a longer period of time.

          • russellsmith55

            This article is an outrage!

            It doesn’t mention that being 100% invested and negatively geared in residential property is guaranteed to make you super-rich. It doesn’t demand an end to mining super profit taxes forever, or mention how the carbon tax is responsible for the imminent murder of all your family members… it doesn’t even suggest we should storm parliament, guillotine every member of the ALP and make Tony Abbott prime minister for the next 50 terms (at least)?!!

            For shame MB.

          • Some of it was mainstream eg, go mining services rather than the miners – pretty much the standard advice from all an sundry.

            On that we agree. Monadelphous has been a favourite of the Sky Business talking heads for several years now.

          • No need for such extremism Russell. The important elements will be rectified via peaceful democratic means.

  2. Funny when you see stories by “Macro Investor” and the Pascometer side-by-side at smh.com.au. Does he know about the nickname you guys have given him?

  3. Who wrote this? Originally said posted by HnH – which is why I said it didn’t sound like HnH. Now posted by Prince…?

        • I reckon we wont get proper kudos from 3d1k until we’ve been published in The Cupboard…

          since we’ve been on telly and MSM press for over a year now i think?

          oh and FT Alphaville just picked up Rumple’s post today…

          • Not sure what this is about – think I have congratulated each writer when picked up by bigger publishers. You are correct though, kudos when in The Oz or feature article in AFR…the two that really count!

          • im sure ive seen minimum twenty cross posts etc. the AFR only matters to people who want their news two days late 3d1k. sorry not trying to be mean, are you serious?

          • he has a point – I read the AFR to gauge the mood of the mainstream, same with The Cupboard. I only buy the weekend AFR paper – if its available at my local, as I find the website to be unreadable…

            Although I find David Bassanesse’s stuff pretty good, although we disagree from time to time…

          • I think the MSM follow this blog. Last weekend’s AFR hard copy felt very MB in terms of strong attention to China, Resources and Property. Certainly no intention of being ‘mean’. If I didn’t think this site was going places I wouldn’t be here.

            What many do not realise is that, without question, the two papers every pollie and CEO pay attention to remain The Oz and the AFR. This is the case even in light of the fact that numerically SMH and Age etc have large readership numbers. These two papers ( Oz + AFR, particularly The Oz but with the rise of Stutchbury also the AFR) talk to the leadership. Better catch up energywonk!

          • haha bot. i reckon the things bogans like is a better gauge of aussie pulse. also take a walk through any bus mall in the country or any hardly normal retail store. i flick through the fin every day just to see how far behind they are, rarely do i find anything that i dont already know. but i take your point.

  4. Great article Chris.
    It is worth noting that the mocro demographics, the ageing of this nation is unprecendented.
    I would like to see the youth (16 and above) who work and pay tax have voluntary voting.

    • Your constant harping on this is a little tiring. Some say that the elderly value add to society and bring a great wealth of knowledge and experience to a culture. Children are just as big a drain on taxpayers (and even more so nowadays with the constant stream of handouts for “working families” that the current government loves so much). I could name a dozen African countries with the youngest demographics in the world that are total economic basket cases. As an older Australian, with a lot to offer, I do not appreciate being talked about as a burden on society and being used as an excuse to sell out the next generation of Australians.

      • The youth must go form exclusion to inclusion and the aged from success to significance.

        You are quite wrong to think that children, who costs are mostly paid by the parents and not the state, cost the state anything like the aged. Just a fact of life.

        I agree with you that our aged are one of our nations greatest resources. Mentoring young business professionals, assistance with childcare, sorting out the asylum seekers problems, to name just a few things they could sort out.

        Can you justify why a pensioner, in a $2 million value home and little cash or investments, should get the full pension, paid by the working class taxpayers? Sure, no-one wants to kick grandma out, however, it hardly seems fair to give her a full pension at the taxpayers expense. Perhaps we could give her the pension as a ‘reverse mortgage’ provided by Centrelink as an extension of the Pension Loan Scheme.

        As for my constant harping? Where have you read any comments I have made in the past?

        • I think you are wrong about the cost of children to the state (taxpayer). Table your “facts of life” if you like – don’t forget the cost of schools, sports fields and myriad tax breaks and offsets.

          The problem with your example is a certain asset class, housing, has assumed holy status in our society, recieving all kinds of exemptions and special treatments. The same pensioner with any other asset to the same value would not recieve a cent.

          I assumed you posted as demografix by your first post here and have seen many of his(/your?) posts obsessing over aging population. So why aren’t the African countries with the youngest demographics in the world, economically successful? The idea of importing more and more people for economic growth is currently being tried, to the tune of a million every few years, and few could honestly argue that things are getting better.

          • On importing people…. I am not for unsustainable population growth. In fact given that our death rates will double in the next 25 years due to the boomers leaving the home planet, natural growth may drop to zero or even negative. There is no way immigration will be doubled or tripled to compensate as the aged voting bloc is too big and has turned anti-immigration already. NIMBY;s will rule.
            4.1 million boomers were born here and due to immigration we now have to support 5.2 million on penssions and with free health. 80% of boomers wwill require full or part pensions, so it was one big kick of the can…..

          • So you don’t see your argument is rife with contradictions? Are the Boomers leaving the “home” planet or are they a burden? and an insurmountable voting bloc?
            (at this point I would like to point out that on important issues both major parties are in furious agreement offering no real choice at all) Why is population growth essential for economic prosperity? Will the new entrants not also age? For if they do you are only promoting a demographic ponzi scheme. What is NIMBY about being against doubling or tripling an already out of control immigration program?

          • “Dystopian
            So you don’t see your argument is rife with contradictions? Are the Boomers leaving the “home” planet or are they a burden? and an insurmountable voting bloc?”

            They will all die, leave the planet and all be dead by approx 2055. They will vote and never before in our history have so many, over the age of 65 as a percentage of our total population, been such a large voting bloc.

            “Why is population growth essential for economic prosperity?”

            I do not think it is.

            “Will the new entrants not also age? For if they do you are only promoting a demographic ponzi scheme.”
            Yes, if we simple bring in people for economic gain, then the Productivity Commission has proven this to be false.

            “What is NIMBY about being against doubling or tripling an already out of control immigration program?”

            Out of control?
            66% of our Net Overseas Migrants are on temporary visas.
            You had better study http://www.immi.gov.au/media/fact-sheets/05emigration_1.htm as the numbers are not that large for permanent settlers. Remember, we count our international students who are here longer than 12 months in our official population growth numbers, even thought now they must return home and do not get automatic residency after completion of the course.

          • No, Peter, it makes it even more important to break the myths that…
            1. Gen X is larger than the Baby Boomers
            2. Gen Y is larger than the baby boomers
            3. Boomers paid tax throughtout their life for the own pension entitlement
            4. Children cost the govt more then thee aged.

            and to get the BB to take responsibility and become part of the solutions.

      • One of the older Australians that now owns most of the housing while the next generation is a bunch of debt slaves? What comes around…

        • Well your time was coming but you got sold out by ponzi demographics with scare tactic arguments like aging population.

          Why your obsession with housing anyway? Why set up house in a transit lounge? I have never owned a house, I saved and invested. I could buy a house outright, am I going to? No! Because they are a crappy investment. I can rent a comfortable house and have enough saved to see out my days here

          • I’m absolutely no fan of renting but that’s just me (I can do the math) – but that’s not the point. The point is the boomers have presided over a system that denied big swathes of the next generation access to the option of the security, joys and family benefits of owning a home without going into debt servitude – it’s most possible that this greed will come back to haunt them. What comes around…

          • Presided = politicians. I agree, the current crop of politicians (both sides) are disgracefully lacking any insight, foresight or leadership qualities and are falling over themselves to sell us out while serving the 1%. Do you think your generations politicians will be any different?

          • Fair point. As i’ve noted many times on this blog the Parties are just corporatised structures with the near sole aim of the pursuit of power. You only have to look at the nil to nothing membership of these Parties to see they represent almost no-one other than the interests of a few. (something the labor party is passionate about hiding).

            So true – the new generation of politicians will just be part of the ‘old firm’ and nothing will change.

          • Then you might find Mr Whittakers advice a bit on the nose..
            “For example, a couple with $1,034,000 of assets as well as the family home, would be ineligible for the age pension because they have too many assessable assets.

            However, if they gifted $10,000 to their children or a charity and invested $11,500 each in funeral bonds, their assessable assets would drop by $33,000 and they would qualify for an age pension of around $1200 a year plus most of the fringe benefits.

            The benefits alone are thought to be worth at least $1500 a year.”

            So according to him, $1million of assets and the family home and you get a part pension. This system is well and truly broken.

      • He’s got a point though. Taxing people under 18 who work and pay taxes should get to vote, otherwise it’s taxation without representation..

        But then again, how many people under 18 actually earn enough to pay tax (esp now that tax-free threshold is $18k)?

  5. Re: The Great Volatility – can’t we just call a spade a spade. It’s a bear market.

    Anyway that’s a minor quibble. Those questions you pose towards the beginning of the article, I am surrounded by people who would be wealthier if they had asked them. Keep up the great work Chris & MB.

    • Minus Zero-Sum Game

      “The buy and hold era is over for stocks.”

      But buy and hold was also generally off, even before the GFC.

      Telstra’s share price peaked at $9.16 in November, 1999. If someone bought $916,000 worth of Telstra in late 1999, it would be now worth around $385,000 (assuming the dividends were not re-invested). In inflation adjusted terms over 12 years, that’s a very poor investment.

      Contrast this to someone buying a 1-bdr or 2-bdr unit in most parts of Sydney back in late 1999. The total capital gain + rent income return has been exponential by comparison to Telstra. Moreover, Sydney unit prices have been hardly touched by the GFC.

      Share investing is now best left to skilled traders. However, most traders fail. I don’t personally know any successful traders. However, I do know quite a few friends who have lost thousands. They either eventually stop, or if they have a professional income, can keep losing for much longer.

      We know that virtually everyone suffers large losses on club poker machines. Well you would have a sore arm trying to lose as many thousands as typically lost on shares.

      I am in the habit of tactfully asking most people I meet if they have ever made good money out of shares. This could be likened to an informal survey. Only one person replied that they made good money out of Australian blue chip shares in the 1990s. Many can’t even afford property or shares. Hundreds of others (the vast majority) responded that they only ever made good money on real estate.

      The financially successful (with property worth assets greater one million) say they never made money on shares. Moreover, they advise to never buy shares. Instead, their advice when starting out is to save a large deposit and then buy cheaper units/apartments in well selected locations close to needed services. Starting with that base, you gradually work your way up to a more expensive property. If only I had heeded this advice 12 years ago, rather than waste my time and money on share investing.

      • I dont know where to start answering that one MZSG – lots of anecdotes and picked stories…Telstra vs what? 100’s of other companies that have succeeded (CSL, COH etc) Sydney market vs say, Gold Coast? Melbourne soon…

        The whole “most traders fails” meme is also a big deflection – the “failed” traders are by definition not traders – the remaining are the ones winning and are professional traders. Just because you don’t know any doesnt mean none exist – I talk to many many traders each and every day who are quite successful. You only ever hear about the failures because only 10% of those who attempt trading stay at it…

        You are correct about the very financially successful – if you look at their asset allocation – something I keep hammering about (remember, that was the 1st question I posed, not the stock picks) – they do not have much in shares. I’ve researched HNWI and UNWI studies intensively to work out how they do it. Property is a part – and indeed property – particularly commercial and developmental property (not residential) is a considerable part, as is investing in yield generating ivnestments, but also speculation via hedge funds and other exotic assets. Shares are a small part of the portfolio.

        Currently, the MacroGrowth portfolio has only 25% in shares….

        • Minus Zero-Sum Game

          Yes, TP, lots of lots of anecdotes and picked stories such as the bad (QAN, TLS, FXJ), and good (CSL, COH etc). However, the vast majority (e.g. including mum and dad type investors) at best tracked the All Ords index. That result since circa 1999 is still inferior compared to Australia real estate. Looking back in retrospect, could anyone realistically expect most retail investors to have obtained a better return? I have suggested a simple trend following system using longer-term moving averages. But realistically, how many retail investors would have the discipline to stick to such a simple system? The minority at best, hence something more is needed which includes a mix of asset classes (Aust real estate, bonds, shares, and cash), providing the best compromise between capital gain/income, but also defensive enough to reasonably withstand GFC events.

          With regards to trading, it is hard work. It can take a decade for many traders to even match the index. I suggest that MB should be realistic about the vast majority of investors who are locked out of the shorter-term higher volatility trading world. I am aware of the maths behind money management (Dr. Van Tharp, Tate, et al). The risk of ruin precludes success for the vast majority. For example, would you ever recommend trading to family members?

          “I’ve researched HNWI and UNWI studies intensively to work out how they do it.”

          Yes, empirical data is what we need. What works in the real world is often different to what organisations with vested interests want us to believe (e.g. certain fund managers, brokers, media, etc). One of my favourite books is The Millionaire Next Door: The Surprising Secrets of America’s Wealthy (1996) by Thomas J. Stanley and William D. Danko.

          I hope that Macroinvestor eventually covers all bases. Not only investing, but also how balanced frugality combined with multiple income streams can be a powerful result.

          Empirical research: a trader who lives home with his parents and saves an average $800 per week. He puts the money into a term deposit. Within a few years he has a large deposit for a cheaper unit positioned in a well researched area. Get my drift?

          • Minus Zero-Sum Game

            Correction:

            Empirical research: a tradie who lives home with his parents and saves an average $800 per week. He puts the money into a term deposit. Within a few years he has a large deposit for a cheaper unit positioned in a well researched area.

          • drsmithyMEMBER

            Within a few years he has a large deposit for a cheaper unit positioned in a well researched area.

            I think the questionable assumption here is that there’s a meaningful difference between “a well researched area” and “a well balanced and risk managed portfolio” to the average punter.

            If real estate drop the ~40% it needs to to align with incomes and rent (and like it has in other countries) over the next few years, how is the average return going to look ?

      • Mmmmm.. If you have bought the SGP PUTS in 2010 and 2011 when I did, you would have made very good returns. I gave this advice out publicly at the time and now I am advising to buy ANZ PUTS. (maybe… ANZSN, ANZJF8, ANZJ18 and ANZU77)

        Disclaimer : I know nothing and you should seek some very expensive legal advice on anything I recommend.

  6. Cap gains in healthcare? At the end of the day with gov paying most of it l think it will continue to be an easy spot for governments to find money by cutting subsidies for healthcare providers.
    Hence l think ‘growth sector’ might be a little aggressive.

  7. Prince, nice twitter link to Ken Henry MRRT and using carbon tax as example, the apparent necessity/inclination for politicians to ‘bribe’ electorate in order to administer tax change. Vested interests are the economy, something tells me Henry knows this only too well.

    • I can still remember the look on Henry’s face when Rudd and Swan bastardized the H report and the resource rent tax proposal to give us the dant na na … Suupppeeerrr Prrofitts Taax.

      (but that was back in the days before Rudd recanted on his love of spin)

      Tax policy reform takes 20 yrs to bubble up through the system in Aust. It’s never been something worth holding you breath on.

  8. “The buy and hold era is over for stocks.”

    Gotta say, as someone who is a contrarian at heart, when the MSM runs a story with a first sentence like that, it sets off alarm bells in my head. Bug*ger, that’ll teach me for having a look at MB while I am (supposed to be) on holiday.

    Only small alarm bells today, as it wasn’t front page news. If you make it to the front pages of the print editions Chris, those alarm bells will be deafening.

  9. “Another sector that used to offer capital gains, but now is the standout in yield are banks. When the credit boom took hold, Australian bank share prices took off, but have now not moved (apart from enormous volatility, which underlies their non-robust business model) for over five years.

    And this is likely to be the course for the next five years, as even though earnings growth is likely to be a positive 2-3 per cent for the foreseeable future, increasing risk to banks balance sheets, either from falling house prices or stricter regulatory requirements, could see more earnings retained and lower dividend payout as a result.”

    Then Australia is indeed different. In all the countries that had sizeable property corrections, their bank share prices got slaughtered. USA, Ireland, UK, Spain, their blue chip pillars just got pounded bewteen 85% and 100% (nationalisation).

    Australia, the land of Unicorns sleeping under rainbows.

  10. LYL??
    LYL got smashed back in the GFC at the hint of a downturn.
    I don’t really know how you are justifying that one.

    • In case you’re wondering none of the above are recommendations – they are examples of what’s out there to illustrate the point between capital gains and yield.

      Indeed LYL did fall a shedload during the GFC – but so far they haven’t in this current downturn, as the capex trend is entrenched, even though commodity prices have come off the boil.

      Can they go down again? Absolutely – tis why I’m always banging my head about risk/capital management – which is a key feature I designed within FARM (actually it revolves around it – should be called RAMF!!)

      For the record, FARM currently rates LYL a “Hold” with a max. allocation of 3% (this is getting smaller as risk increases), with the FY12 estimate of value just above $9, growing to slightly over $10 in FY13, IF, forecast earnings eventuate.

      As for MND, FARM has its FY12 estimated value at $22, moving to $27 in FY13, also has a “Hold” with a max. 1.8% allocation.

      Hope that clarifies.

  11. anonysubscribe

    is this value?
    vs simplistic growth?
    top down before picking the best stocks in the best sectors?