Kreston marker update week ending Friday 12th march 2010

Kreston ANZ

Insights

News

Kreston Dormers

Kreston Dormers Financial Services Pty Ltd

The ASX 200 had a solid 0.9% as overseas markets had strong weeks. Energy was the standout sector as Shell made a bid for LNG producer Arrow thus other energy company prices rose. Property fell 1.9% due to last week’s interest rate rise.

We are near the top end of the 4,500 to 5,000 trading range we have been stuck in for the past 6 months. Can we break out of that range? It is difficult to see what the short term catalyst for a break out would be and volumes are not high (which usually indicates a weak trend). We will probably remain in the range for the short term.

	Friday	Week	%
All Ordinaries	4,834	44	1.0
S&P / ASX 200	4,822	43	0.9
Property Index	870	-17	-1.9
Utilities Index	4,838	76	1.8
Financials Index	4,807	19	0.4
Materials Index	12,557	108	0.9
Energy Index	15,472	576	3.9

Deposit rates have also been rising for terms up to 3 years as banks compete for funds. We expect this upward trend to continue.

Term	Rate %	Change in rate
3 months	5.40	0.05
6 months	5.95	0.09
12 months	6.31	0.26
3 Years	7.0	0.15
5 years	7.10	-

There were solid gains in overseas markets led by the US S&P 500 up 2.4%. European markets also rose and the UK’s FTSE was 1.6% stronger and has risen 6.3% in the last 2 weeks as Greek debt concerns recede. In Asia, the Nikkei had a strong week up 4.0% which extends their gains to 6.3% over the past 2 weeks. Hong Kong’s Hang Seng rose 3.2%.

Australian economic news has turned from avoiding the credit crisis to managing the recovery.

Overseas, the BIG 3 economic concerns receded (a little).

In the feature section, we discuss the outcomes of our ‘micro-survey’ on investing emotions we have seen over the past few months.

Australian News

Australian economic news has definitely turned from ‘avoiding a crisis’ to ‘how do we manage the buoyant conditions over the next few years?’ In fact, one analyst bullishly announced that their numbers suggested the government budget would be in surplus by 2012. A cynic would respond that this assumes no further government spending announcements. In an election year that is unlikely.

The Reserve Bank of Australia warned that unless housing supply improves, house prices and rents will continue to rise. Their concern is that skilled labour shortages are looming which in turn will lead to further gaps in housing supply as other industries compete for tradesmen.

High population growth, planning regulations along with bank reticence to lend to property developers means that demand is outstripping available supply.

On that theme, owner occupied housing approvals dropped 7.9% (seasonally adjusted) in January from December 2009. The expiry of the First Home Owners Grant and the rise in interest rates would have had some impact, albeit the drop in approvals is probably temporary.

Australian unemployment came out at a steady 5.3% (seasonally adjusted) for February (note that January’s rate of 5.3% was revised down to 5.2%). The result was a little weaker than expected but the trend over the past 5 months has been very strong.

Overseas News

The ‘Big 3’ concerns faded a little this week :

   •   Greece was able to refinance part of its debt last week. Other Euro countries such as Portugal reiterated and strengthened their debt management strategies.

   •   Chinese Premier Wen Jiabao announced China’s economy would grow by 8% next year. While there is no detail on how this might be achieved, it would be a ‘not too hot’ not too cold’ result. The market did not take him at his word but it did seem to reduce some of the concern about China overdoing the exit from its stimulus package.

   •   US economic data continues to point toward a recovery e.g. unemployment in February held at a better than expected 9.7%.

Chinese economic data showed a rapidly expanding economy with January/February retail sales up 17.9% on the previous year and factory output up 20.7%. Power generation, which is a good indicator of economic activity, rose 7.9%.

For every bit of good economic news there is a flip side. Inflation in China rose 2.7% in January/February compared to the previous year which is probably a signal for more interest rate rises and other ‘dampening’ measures.

On the European front, regulation of Credit Default Swaps (‘CDS’) is being pushed by European and to some extent, US regulators. A CDS is a form of insurance that a lender can take out against a borrower defaulting. For example, a European bank may agree to repay a buyer of a Greek government bond if the Greek Government defaults or cannot repay the bond. The CDS can be traded (bought/sold) on the market.

What has been happening is that CDS’ over Greek government bonds have been bought by traders despite not holding any Greek government bonds. They expect the price of the CDS to rise as the Greek government may struggle to repay the debt (and therefore companies that want to insure their Greek government bond will pay more for the insurance).

These are called ‘naked’ CDS.

The problem is that it is in the interest of the buyer of the naked CDS to increase concerns over Greece’s ability to repay as the CDS will rise in value.

Greek Prime Minister Papandreou used an analogy that buying a naked CDS was like taking an insurance policy over your neighbour’s house. You would be happy for it to burn down as you would receive the insurance money and you don’t need to use the money to rebuild the house.

There is some merit in this view although the underlying issue with Greece is that it has a debt problem and it lacks credibility in managing its debt.

Expect some regulation of CDS as the European banks are ‘up to their ears’ in CDS exposures and European governments will take action to prevent further pressure on their banking system.

Emotions when Investing

We have discussed the emotions that impact people’s investment decisions in past Weekly Updates.

Given that the market has risen by over 50% from its lows and we experienced a 9% correction over January and February I was interested to see what emotions our advisers have been seeing in their own and client decisions.

After reaching 4,950 in mid-January, the ASX 200 fell 9% to 4,500 in mid February. The market had previously traded at around 4,500 in August 2009, mid-September 2009 and November 2009. Personally I was very happy when the market rose to 4,500 in August and September 2009 but on the other hand I was not happy when it retreated to 4,500 in February 2010.

In February, the rational part of me was saying that the economic news was quite positive despite the Greek debt issue. In fact the economic situation in January/February is significantly more positive than in August/September/November 2009.

The emotional part of me was the reason I was not happy in February 2010 in that the market had reached 4,950 and I had somehow ‘lost’ 9%. This is despite previous Updates highlighting my rational expectation that we would see 10%+ corrections after our 50%+ rise from 2009 lows. Was ‘fear’ the driving emotion? Now I have some regret in that ‘I should have bought more when the market was at 4,500’.

After over-analyzing myself I undertook a micro survey of the advisers in the office which highlighted a few recurring themes over the past few months.

Anchored to the Past – net wealth

Similar to the feeling of loss (above) when the market fell 9% in January/February 2010, investors still have an anchor to previous peaks in their net worth. Naturally we think ‘wont it be good when I am worth $x again’ and promise to ‘do to things differently once we reach that peak again’.

Whilst learning lesson from the past, rationally we should be reassessing our current circumstances and revising our investment strategies with what we expect to happen in the future, rather than with regret as to what happened in the past.

Anchored to the Past – taking profits and losses

Another variation on the above is not selling a share because you will make a loss. This is often accompanied by, ‘I will wait until I recover the losses before I sell’.

On the other hand, investors seem to be more willing to sell shares where they have made a profit. In this case, the ‘anchor’ is the lower purchase price of the share.

A more rational question to ask in these circumstances is ‘Can I make more money in an alternative investment?’ A past profit or loss should be irrelevant to a current investment decision.

Narrowing Investment Timeframes

We have found that when markets have fallen that investors tend to talk in much shorter investment timeframes. For example, questions are asked around where the market going over the next day, week or month.

On the other hand, when the market is rising, optimistic investors look more to their longer term plans.

In some ways this is the opposite of what we should be doing as investors … to quote Warren Buffett ‘sell when others are greedy and buy when others are fearful’.

Confirmation Bias

We often see investors and analysts looking for information that confirms their investment decision or opinion rather than being objective and reassessing views and opinions on all information presented. An element of personal ‘worth’ is associated with being wrong (or right) in a decision or opinion.

You often see this when commentators stick to predictions or positions in the face of overwhelming evidence to the contrary. For example, one Sydney-based academic has held to his very publically expressed view over the past few years that ‘Australian housing prices are highly overvalued and we will see a crash’. He now blames the government for his prediction not eventuating and has recently changed his tone to ‘Australian housing prices are highly overvalued and we would see a crash except government policies wont allow it’. He is still to admit his prediction was wrong.

The best investors admit when they have been wrong and move on (and we have all been wrong at times). Warren Buffet is probably the most notable example of a rational investor. Despite running and owning a substantial portion of US based Berkshire Hathaway, he often publically advises investors not to buy his company’s shares when he thinks they are too expensive. There are no discernible emotions to his investment decisions.

Confirmation Bias – some natural tendencies

A variation on the above is that individual investors have natural biases toward caution or optimism. Those with a cautious bias tend to focus on and remember negative news stories or experiences, while vice versa for those with a more optimistic bent.

There is nothing wrong with either trait as long as you recognize where your natural tendencies lie. To provide balance you should then test your opinions with other commentators/advisers you trust.

Conclusion

It is impossible for us to remove all emotion from our investment decisions.

Nevertheless, we should be aware of our emotions or natural tendencies when investing. Having someone to act as a ‘sounding board’ to test whether our actions are rational and balanced is critical.