Is the current Aussie share recovery going to last?

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After being dragged down by the global financial crisis, Australian shares have made a come back. But is this improved performance sustainable and how does this compare to previous recoveries?

Profitable or not?

Investment author Rob Arnott once said: “In investing, what is comfortable is rarely profitable.”₁

Investing in Australian shares over the past decade has certainly been anything but comfortable. But has it been profitable?

Over the long term, the answer is a resounding, “yes”. Including dividends, the Australian sharemarket returned an average return of 9.26% per year over the 10 years to 30 June 2013₂, outperforming cash by 4% per year on average. However, the result over five years is less impressive, with the sharemarket only returning an average of 2.70% per year, 1.76% less than cash.

Previous setbacks

And this is not the first time Australian shares have suffered a serious setback. Over the past 30 years, Australian shares have suffered four major dips:

1. 1987 sharemarket crash
2. Bond market crash of 1994
3. Bursting of the internet bubble in 2000
4. Global financial crisis of 2007-08

These dips are painful at the time and memorable for many years afterwards. Many people will recall the All Ordinaries rising to 6853 in November 2007 before crumbling to 3111 just 16 months later in March 2009. The Index has subsequently risen above the 5000 mark on six separate occasions but been unable to sustain the increases.

The long term view

At times like these, it is important to keep your eye on the prize. On 8 August 1984, the All Ordinaries Index closed at 782.5. On 8 August 2013, 29 years later, the All Ordinaries Index closed at 5047.1. That’s a whopping 544% increase, without even taking dividends into account.

Over time, even major traumas such as the 1987 crash can seem like a small blip on a strong upward trend. The number of financial years on which Australian shares has recorded rises outnumbers the number of years with falls at a ratio of 3:1 over the past 20 years.

The key lesson to take from this is that the people who succeed in the sharemarket tend to take a long-term view and have the discipline to stay the course when times are tough and avoid the temptation of piling in when the market is running hot.

Lessons from history

So what has caused the painful periods of poor performance? All four periods of sustained falls referred to above have been preceded by periods of very strong sharemarket returns. For instance, in the mining boom fuelled rally from 2003 to 2007, the All Ordinaries index rose from 2673 in March 2003 to 6853 in November 2007, a rise of around 156%. And in the period famously characterised as, “irrational exuberance” by US Federal Reserve Board Chairman Alan Greenspan₃, the All Ordinaries rose from 1204 in January 1991 to 3152 on the last trading day of the millennium, a rise of 162%.

Worldwide crash

BT Chief Economist, Chris Caton, says the primary cause of the Black Monday crash of 1987 was the significant rise which preceded it. “The worldwide crash was caused fundamentally by sharemarkets being overvalued, particularly the US market,” he says.

The price to earnings ratio (a common measure of the relative value of sharemarkets) in the US sharemarket reached around 20 times earnings in October 1987, well above the historical average of around 15 times earnings.

“Price to earnings ratios clearly showed the sharemarket was in a bubble. And, as we know, bubbles always deflate,” Mr Caton says.

Largest one day loss ever

And deflate they did. The Black Monday crash produced the largest one day sharemarket loss ever recorded. The Dow Jones Industrial Average in the US fell 22% in a day while Australia’s All Ordinaries Index shed 25%. By the end of the month, the Australian market was down 42%.

The internet boom

The most famous bubble of them all is that which enveloped the US sharemarket in the late 1990s with the internet boom. The price to earnings ratio of the S&P 500 index peaked at around 32 times earnings₄ at the height of the exuberance in December 1999, around the same level it achieved just prior to the sharemarket crash of 1929 which lead into the Great Depression.

The magic mark

The resulting sharemarket correction between 2000 and 2003 was further compounded by the terrorist attacks in New York in September 2001. The S&P 500 Index took more than seven years to go back over 1500 in June 2007, just months before diving again at the onset of the global financial crisis in November 2007. It took another five years to again rise above the magic 1500 mark in January 2013. It has subsequently risen above 1700 for the first time in its history.

What’s in store?

With the US market showing bullish signs, what are the experts saying about the outlook for Australian shares?

To answer this question, it is important to remember that the strongest influence on our sharemarket is the outlook for global growth, particularly the US.

Signs of growth

BT’s Chris Caton says the US economy is showing signs of growth, albeit at low levels.

“The latest figures show the US economy is limping along with GDP growth of 1.4%,” Mr Caton says.

“Most economic indicators point to slow growth in the US, however, there is the possibility that the economy may surprise the market on the upside. Housing has turned around, exports are improving and the jobless rate is shrinking. However, ‘surprisingly’ strong growth in this context is around 2.5% per annum, still below historical average.”

Mr Caton says the US economy is, “the best house on a poor street”. Europe is still struggling under its debt burden, Chinese growth has slowed and Japan has still not kick-started its economy.

The consensus view

The consensus view on the All Ordinaries Index at the start of 2013 was for the All Ordinaries Index to end the year below 5000. At the time, Mr Caton was more optimistic, believing a figure of between 5200 and 5300 was more likely. He says his current view was the All Ordinaries would rise to around 5500 by 30 June 2014.

1. Matthews Asia “Perception vs. Reality: Exploring the Misconceptions of Frontier Markets” Morningstar.com, 8 Jan 2013
2. Source: IRESS
3. Alan Greenspan “The Challenge of Central Banking in a Democratic Society” Speech to The Federal Reserve Board, 5 December 1996
4. Joseph Capital Management, “75 Years After The Crash” December 2004

The above information provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. The information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness having regard to these factors before acting on it. Please note that Chris Caton is employed by BT Financial Group.