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Making money in volatile times

David Taylor

 

These days you can’t make money without an adrenalin rush.

So how the heck do I get a decent return these days without suffering a coronary?

What does it take to produce a high-yielding investment portfolio right now? Or better yet, where’s the ‘smart money’ going at the moment?

Those answers to come, but first let’s set this up a bit:

If you’ve been listening to any of the market commentary recently you’ll know the markets have been volatile – unusually so. At the core of the problem is uncertainty.

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There are several reasons for this.

Firstly, markets are trying to work out just how fast China’s economy is slowing; secondly, there’s ongoing revaluation of commodities prices as figures change and move around on that growth projection; and there’s constant speculation about when the world’s largest central bank, the Federal Reserve, will start to raise interest rates.

Domestically, there’s been a noticeable lift in confidence since the announcement of a new prime minister, but generally speaking big business are worried about sentiment among consumers and the fact that any reforms ‘magically’ created by ‘roundtable’ discussions will ultimately have to be passed by the Senate – which lands PM Malcolm Turnbull in the same pile of policy reform doo doo as his predecessor Tony Abbott.

The result is that businesses are still reluctant to commit to both capital spending and long-term hiring of labour. That’s generally a negative for industrial stocks.

Concerns around the general health of the Australian economy, and markets abroad, are not creating an easy stock picking environment.

Cash is king again?

According to the Australian Taxation Office, Self-Managed Super Funds held $157 billion in cash in the June quarter.

That figure is up from the $155 billion quoted in the March quarter and shows cash makes up almost 30 per cent of the asset allocation within any given portfolio.

Historically that’s significant I think.

After September’s horror stock market performance we saw overseas investors take on similar positions.

Also read: Shares down as investors reap profits

According to the Wall Street Journal, mum and dad investors reduced their equity allocations in their investment portfolios by around 2.5 per cent last month to a 10-month low.

At the same time cash holdings rose around 1.5 per cent to just under 19 per cent.

The message is clear I think. When the market corrects, or comes close to correcting, folks that want a reliable investment return switch to more reliable asset classes.

The problem at the moment is that there’s almost no such thing as a “reliable” investment outside of cash. And within the asset class of cash returns are pitiful.

I dare you

So the answer is simple then really, isn’t it? If you want a reasonable return, invest in the share market and hope for the best, right?

Well if you had taken that approach last week you would be laughing.

Last week the ASX200 index rose for five straight days, providing investors with the best week of share trading in nearly four years. Mining and energy firms lifted on higher commodities prices, and the banks recovered as well.

Also read: Best week for investors in four years

You would have needed nerves of steel though because both August and September provided investors with some stomach-churning market falls.

In America at least, many retirees do have nerves of steel. Wall Street columnist, Brian O’Connell, recently pointed out that many Baby Boomers close to retirement had stock allocations higher than those recommended for their age group.

Nearly two in every 10 investors between the ages of 50 and 54 had a stock allocation at least 10 per cent higher than recommended.

Why? Because they want a higher standard of living than what a term deposit can provide.

What about bricks and mortar?

The property market has certainly had its attractive qualities in the past.

Two obvious qualities have been the access to negative gearing (where costs exceed revenue and tax benefits are gained), and of course capital gains.

Three developments in recent years have created an extraordinary amount of interest in the market. The first is that Australia’s unemployment rate has remained relatively low.

Basically plenty of people in Australia still have jobs, which means going to the bank manager and asking for a loan hasn’t been too much of a problem.

The second is a strong amount of domestic and foreign investment. And the third is that the official cash rate has been heading towards historic lows, and standard variable interest rates have followed.

Perhaps most important, however, is that despite cries of overinflated property prices, the Treasury Secretary saying that Sydney house prices were “unequivocally” in a bubble, and the RBA governor calling prices “crazy”, house prices continue to rise.

That’s creating, at least for the moment, a feeling that prices will ‘always’ rise. When enough of that kind of thinking makes its way into the market, you’re in fact heading towards o a “Ponzi scheme”-style investment (where investors benefit simply from a continuation in price rises – despite there being no fundamental reason for it) and it’s anyone guess as to how hard that could fall down.

Also read: Will population growth impact property investors?

A few weeks ago I spoke to one of the lead real estate agents from an inner-Sydney city suburb. I shouldn’t have been, but I couldn’t help but be shocked by what she said.

She explained that she had just sold what she described as a dump in a ‘middle-class’ suburb for $980,000. She said the property was virtually unliveable.

She revealed to me that the owners were going to tear it down, and spend around $340,000 renovating the property. It was her understanding they were going to sell the property in around 6 months’ time for well over a $1 million.

I asked her, “why?” she said, “one word: money”.

Investors believe prices will continue to rise, so borrowing money to purchase any sort of property with potential is a ‘no brainer’.

With some of the top economic minds in the country saying otherwise, for my mind, it would take a lot of guts to take on a large mortgage in the current climate, in the hopes of making a capital gain. People are doing just that, however, and walking away with big returns.

I should point out that figures released last week from the Bureau of Statistics showed that loans to property investors fell during the month of August, in contrast to owner-occupier loans which rose over 6 per cent.

The banking regulator is trying to clamp down on excessive property speculation and – at least on these numbers – is showing signs of working. That said, however, owner-occupier loans shouldn’t have made up the difference.

So what’s my point?

My point is simply that whether you look to the property market or share market, there are above-average returns to be made – they’re just not there all of the time… and could really come to a grinding halt at any point really. Indeed if your investment horizon is short term, you’re in for one heck of a ride.

Fortunately, the roller-coaster is regularly heading up.

If you’re looking over the longer-term (and value your sleep at night), it’s hard to work out whether you’re better off in cash or low-yielding equity.

Recent trends suggest perhaps cash in back in vogue, especially if you’re a believer that longer-term interest rates are on the rise, or they are about to rise.

If you’re looking for returns of anywhere between seven and 20 per cent, the amazing part about today’s investment climate is that they’re possible… whether or not you’ve got the ticker for it though is a whole other question.

David Taylor is a journalist with the ABC. Before taking up a position with the ABC, David was a financial markets analyst and economics commentator.