Why Fund Managers Could be Doing You a Favour

Every so often the Money Morning mailbag receives a note saying, “Can you quit the property bashing already!” – Or words to that effect.

Funnily enough we get that request from both property bulls and property bears. The bulls claim they’ve heard it all before and yet property prices keep going up. While the bears suggest we’ve made our point and shouldn’t labour the point too much.

I guess the problem is that your editor suffers from a not-so-rare condition called Pigheadedness.

But to be honest, as I’ve written before, the issue of the property market can’t be ignored. It’s an integral part of the Australian economy. Just remember that around 50% of all bank lending goes to the housing market.

That means the influence of property on the Australian economy is huge. It’s just as important to the Australian economy as the resources industry. Perhaps more so when you consider the massive borrowing in property.

Besides, the property spruikers pollute the airwaves and print media everyday spouting their bubble-enhancing propaganda.

If nothing else, we’re quite happy to be a thorn in their side to smack down the lies they come out with.

In fact we were going to take another swipe at them today but we thought we’d leave it until Monday as we’re looking forward to seeing what RP Data and Rismark have to say when they release their median or hedonic indices today.

Anyway, that’s for Monday. But today this…

When will the stock market bubble pop?

The S&P/ASX 200 had a nice little up day yesterday. But it was a drop in the ocean compared to the 200 point drop suffered over the last week, as you can see from the following chart:

And contrary to everyone’s thinking, the Australian market still hasn’t ‘de-coupled’ from the US market:

There’s not much difference at all between the Australian S&P/ASX 200 and the US S&P 500.

But what can explain the falling prices? I mean, especially when you see headlines like these on Bloomberg News:

“Microsoft Profit Beats Estimates on Release of Windows 7 Operating System”

“Amazon.com Profit, Sales Exceed Analysts’ Estimates on Holiday Discounts”

“Ford Posts $2.7 Billion Annual Profit After Record Loss, Beats Estimates”

Doesn’t that mean the good times are back?

Then in Australia we’ve had headlines such as:

“Woolworths 1H Total Sales Up 4.2% On Year.”

Of course Woolworths’ results were below analysts’ expectations and so the share price was hammered, falling 5.8% over the last couple of days.

Well, the problem for markets is just that of ‘expectations.’ And considering the stock market has already gained 43% since the start of the year the outlook has to be really good if investors are going to be convinced to keep buying.

Not only that, but you shouldn’t ignore the thought processes of the parasitic fund managers either. Take a look at the ten-year chart of the S&P/ASX 200 first and then I’ll explain:

Three years of gains in seven months

The market has gained the same amount in just seven months as what it previously took three years between 2003 and 2006.

I don’t know about you, but if I was one of those lucky fund managers who managed to keep their job while others were being thrown out on the street I’d be pretty keen not to stuff up.

And one way of not stuffing up is to protect your winning position.

It’s one of the flaws in the whole ‘weight of money’ argument. We thought the weight of money theory would have been dashed on the rocks during the last down turn.

If you’re not familiar with the idea, the weight of money theory went something like this…

Because there was 9% of every Australian’s salary being invested every year, and because a big slice of that was invested in the stock market, the ‘weight of money’ would help to prop up share prices.

Sounds reasonable doesn’t it. If everyone buys and no one sells and with all that money flowing into the market then share prices can only ever go up.

Only, that didn’t happen. And it won’t happen again. But that hasn’t stopped the superannuation weight of money theory being trumpeted by the mainstream again. However, there’s a simple reason why the theory is flawed.

Simply put, no one wants to be the last one on the sinking ship.

If you imagine a ship with a hole in it. And that there’s just enough people on board to be able to bail out the water so it doesn’t sink.

But then someone figures it’s pretty tiring work so they give up and get in one of the life boats instead. So everyone left has to bail faster, making them more tired. So then others start to prefer the safety of the life boat too.

You can picture what would soon happen. At some point the realisation would come that no-one wants to be the last one on the sinking ship. So they all head for the life boats and the ship starts sinking faster than ever.

Time decays your returns

It’s the same with this phase of the market. With the index up over 40% in less than a year plenty of fund managers will be looking for safety. And do you know what, I don’t blame them.

But that means unless there’s some really hot economic news on the horizon there will be little incentive for fund managers to put their clients funds at risk… sorry, let’s be honest about it, we mean their own bonuses at risk.

More likely – and we could be wrong – is that even if the market doesn’t fall off a cliff, then time will erode investors returns this year.

Think about it this way. From the market low of 3,120 in March 2009 until it reached 4,900 points in October, that gave the market a staggering gain of 57% in seven months. If you annualise that you’re looking at around a 97% gain.

That’s pretty darn good by anyone’s standards. Four months later and from the March low the index is now only up 47%, or 52% on an annualised basis.

That’s still very good and not to be sneezed at. But thanks to time, the annualised return has nearly halved in just four months.

You could argue that it was only annualised and therefore the 97% was never really there. That’s true. But the point is how impressive will a 47% gain from March 2009 look in September 2010, or March 2011?

Not quite as good. And that if the market manages to hold on to the gains it’s made.

If investors start heading to the life boats, then the joys of a 47% gain could soon be nothing more than a pleasant memory.

Maybe, just maybe, this could be one of those rare occasions where the interests of the investor and the fund manager are closely aligned. Just don’t bank on it lasting that’s all.

Cheers.
Kris.

Why Fund Managers Could be Doing You a Favour, 8.9 out of 10 based on 8 ratings

Tagged as: Australian economy, fund manager, investor, property bashing, property bears, property bulls