Free air welcomes the All Ordinaries, following the recent surpassing of the 2007 peak. Reading much of the commentary from investors and experts alike, it appears that this is a cause for concern. Indeed, making money can be a very stressful exercise.
My facetious comment is born from an ongoing frustration that seems to affect many Australian investors in that when markets are going down, we worry for obvious reasons. Yet when markets are going up, we worry the next move will be down – and when markets move sideways; we worry that if anywhere, it will probably be down.
Investors are fixated on tops and bottoms of the market, too often missing the significant bits in between which are the biggest contributors to sustainable long-term portfolio performance. Rather many question whether this latest run is sustainable, and is an imminent correction just around the corner?
Before anyone panics, it might help to remember that we’ve been at all-time highs before. Since 1980, 18% of all months closed at an all-time monthly high. The first of those being when the All Ordinaries hit 546 in January 1980. With 47 other subsequent monthly all-time highs, including this July, and over 1100% growth in the index since, it’s fair to suggest that using a new peak as a reason to sell would not be a smart long-term investment decision.
However, the new road to redemption for the All Ordinaries Index has been a drawn-out 11+ year process. It has been our market’s longest peak-to-peak recovery, challenged only by a prolonged period in the late 1800s when share markets in Australia were still state based. It recouped even the great depression correction in five years and ten months, and the 87-crash recovered in six years and four months.
Adding to the significance of how long it has taken our market to return to all-time highs, the Dow Jones in the US, despite being the nucleus of the GFC, took a little over five years peak-to-peak. That process was even shorter when you consider the payment of dividends as the Dow Total Return index completed the same process in three years and seven months. Here in Australia, the All Ordinaries Accumulation Index (XAOAI) took six years and one month to complete the same path.
Source: Lincoln Stock Doctor
So, why do I seek to pour cold water on what some in our local industry see as a significant event?
The All Ordinaries index reflects the price of the largest companies given their weighting. Only BHP and RIO have returned close to 2007 levels. In fact, while the market being ‘at all-time highs’ suggests everyone is making money, spare a thought for AMP, Santos, Telstra and bank shareholders who are still in the red since November 2007. Though in the case of the latter two, dividends have helped absorb some of the impacts of capital decline from a total return perspective.
Herein lies the reason why we believe the market level is irrelevant for proactive long-term investors. Ultimately, we believe that the benchmark is simply a poster boy for inertia, dominated by mature businesses, often staid in their corporate ways. While lethargic investors may champion this measure of mediocrity doing well, the reality is that for a proactive growth-seeking investor focused on bottom-up stock picking in order to find future leaders, rather than yesterday’s heroes, they should have done better.
The returns we make on the companies we invest in will drive the performance of our portfolio, irrespective of index performance. Engaging in bottom-up investing aims to identify the elite companies to hold and avoid the stocks that drag you down. The market doesn’t discriminate based on quality, only size, and that in our view, is to the advantage of the proactive investor.
So, can the index make a new high next month and beyond? The answer depends on what happens to the companies within it. We feel there are adequate drivers to support a continued rise as conditions will remain accommodative for some time yet. With falling interest rates, strong corporate performances and supportive governments globally, it is our view that quality businesses will reap the rewards and deliver excess returns for investors, irrespective of where sentiment may take us in the short term.
However, that doesn’t mean we should be negligent in the management of our portfolio, and not proactively manage portfolio risk. Significant gains should always be banked through disciplined re-balancing regardless of where market levels sit. As Fund Managers, this is a process we regularly undertake. Not only does it allow us to manage overconcentration risk, but it helps build our cash pool that sits at the ready to deploy into great quality companies where the opportunities loom largest. When that will occur, no one can tell you, just let facts rather than predictions guide you there.
One thing is for sure, we won’t be deploying that cash in the laundry list, which is the market index. History tells us that in recovery, the money flows back into quality stocks unfairly sold off first. The index is then left to contend with the other underperformers who drag the pace of recovery down and keep the All Ordinaries, quite frankly, ordinary.