Stock market crash - Free Financial Advice for Australians

The only upside we can say about these markets at the moment is that they will be something to tell your children or grandchildren about… "Let me tell you kids, I was in that perfect investment storm in the middle of 2008".

I haven't seen anything like it since 1987. On that rainy afternoon in October I remember looking out over North Sydney from my 20th floor office and thinking "This is serious. World wide carnage on all stock markets." Well we have had the same again now. It's been more painful but not as swift as 1987.

There was talk last year of the de-coupling of our markets here and in Asia from the US, meaning if the US went into decline it wouldn't necessarily follow that we would follow. Well fat chance! Our markets have dropped further than the US. There now seems a re-coupling of the de-coupling. As we can see below we have fallen harder than the US or the world index.

The US, UK and NZ are all on the brink of recession. Some European countries look like they will follow suit, especially Spain. In Australia our woes are well known. We have a huge leverage problem in the household sector with property prices far too high with rising inflation. Forget the sub prime crisis. If we start to have job losses we will see problems with prime loan mortgagers and some defaults will occur. Banks will be reluctant to lend at the same levels as previously and the property market will correct over the next 18 months. We may well have reached the peak as far as the Australian dollar is concerned but we still have demand from China for our commodities.

The worst returns for 25 years

Wow! That's a record we wish we hadn't beaten. Australian shares declined 14% over the 2007/8 financial year - the worst result since 1982 - compared to the global share market decline of 15% in local currency terms. This decline was dominated by the US (S&P 500 Index) which declined 8.6% in the month of June alone. Can't wait for the July figures! This was the second worst June result since 1796. The only worse result was during the great depression in 1930. There, that should cheer us up.

Then just as we thought the worst was over we had the bad news about Freddie and Fannie, which sent financial stocks into a further spin. The best performing stocks since November have been those exposed to energy and the worst have been the financials like banks etc.

When will it get better?

There are differing opinions as to whether we have reached the bottom and the knife has hit the floor, but for me the World Youth Week was the worst week for the markets I can remember. We will call it a Papal floor. Margin calls and tears. We are definitely now in a bear market.

So if we assume we have hit the bottom what happens from here? Well according to analysis from our friends at Platypus Australian Equities (who many of you will be familiar with as these guys have one of the top performing share funds in Australia), since the 1950s whenever we have experienced a correction of 20% or more it takes 66 to 180 weeks for the market to reach a new high. The most optimistic outcome based on historical experience would be for the market to reach a new high in June 2009.

A more typical pattern after a decline of this magnitude would be a trading range that persists for a few years. The best guess would be a trading range from 4750 at the bottom to 6000 at the peak over the coming months. If the market was to reach 4750 this would be less than a 12 times earnings multiple, the lowest since the recession of 1991, and would represent exceptional long term value.

At the moment all markets seem to be trading inversely to the price of oil. Movement either way can affect the market. These prices and how they will impact on the market will be seen in the reporting season in August. No one is expecting an upbeat result and much of the bad news has been factored in to local stock prices already. So unless there are more major surprises we should see the market slightly up over the next month.

What should we do?

None of us have a crystal ball but you might be asking should we cash up and wait for the market to return to a more even keel? Well according to some interesting stats that's the last thing you should do as the best gains are made during down times.

The following figures compare different performances before and after a recession in the US. I don't have figures for the Australian market but as we are so closely linked I am assuming they would be pretty close. Remember these figures are for the index as a whole. Our aim would to always beat the index (more on index funds next month and why we don't recommend them).

By looking at the numbers for the last nine recessions, we see some surprising and encouraging figures.

The largest market losses, as you would expect, are in the beginning of any recession, crash, correction, call it what you like. The largest gains come from staying invested through the entire period. The numbers show market timing would have given you an 8% gain at best and a -3% loss at worst.

For the last 50 years, the average return for the S&P 500 has been around 12.5% p.a. Investors focused on the long term, who didn't panic and who stayed fully invested in the market during this time, found themselves with an average return of 42.4%.

So what should you do? The answer is to hold your course at this time; your asset mix is still sound and your financial goals have not changed.

So those of you, who have been keeping your powder dry waiting for an opportunity to invest for the long term, wait no longer.

We all know in the end that over time the stock market will outperform cash and property but it certainly takes a sound strategy, the right asset mix, a good adviser and nerves of steel to hold your course.

I will leave you with a quote from Warren Buffet who, unless you have lived on a deserted beach for the last 50 years, you will know is one of the most successful investors of all time and one of the richest people in the world. In other words he gets it. There is simply no superior alternative to investing in shares. The long term returns of every other asset class pale by comparison.

Stock market crash - Free Financial Advice for Australians

Will this carnage ever stop?

The worst returns for 25 years

When will it get better?

What should we do?

Article originally published in July 2008.

Venn Williams - Halogen Pty Ltd