Weekly Wrap Up

Good news is a scarce commodity at the moment in both the political and investment worlds. So it is hardly surprising that the federal treasurer, Wayne Swan, was delighted to spread the message about our better than expected gross domestic product (GDP) growth figures for the June quarter. The icing on the cake was that the March quarter was not as bad as initially reported and was duly revised up, but the headline grabbing number was the 1.2% rebound in GDP growth for the June quarter and the sharemarket responded positively to the news as might be expected. Could this be the signal that the worst – for the Australian economy at least – is behind us? Given the strong long-term relationship between the sharemarket and the economy it is not surprising that analysts and media coverage focuses on expectations for an economy’s near-term performance. However, analysis of a range of economic indicators over 50 years in the US and 25 years in Australia by Vanguard suggests we should treat macroeconomic indicators with caution when it comes to their forecasting ability. The research looked at the returns for the subsequent 12 months for equities and government bonds following a change in economic signal and found that the likely return outcomes did not alter significantly. This reinforces the challenge that comes with trying to forecast future market returns – attempting to time markets, particularly in periods of strong volatility, is fraught with risk. An oft-quoted expression is that no-one rings a bell at the top or bottom of a market and that rings true here. Yet in periods of market volatility, it is not surprising that investors are cautious – and perhaps inclined to sit on the sidelines waiting for a sign that better times are here. Yet that is not a risk free option either. Market studies tell us that missing the first three months of a sharemarket rally can be costly. Between 1956 and November 2008, when there were 11 significant market declines of varying length, the average return for the first three months of the subsequent market rally as measured by the broad US S&P500 market index was 15.6%. The average return for the first year of the recovery was 34.5%. That is the risk of being out of the market during the first leg up of the recovery phase. Of course you can also be “wrong” by investing too early. This is the argument for dollar cost averaging or investing into markets over time. It mitigates against the timing risk of making a one-off investment decision and diversifies the investment over time. It also can provide the framework that allows investors to tune out the short-term market noise – both good and bad.