Tuesday, September 07, 2010

Should we Still be Worried? ... I Say No

I am optimistic about markets going forward. I went to a good presentation last week on sovereign debt issues and impacts on global markets.

The fact is that, so long as we assume that markets are relatively efficient, all of the issues that may give cause for alarm are already factored into prices today. When you buy a share in a company today you are buying an entitlement to a share in all of the future earnings of that company and the price that you pay is the best estimate of those future earnings, discounted back to today's value. If company earnings are likely to be lower in the future then today's price of the company's shares is lower.

The expected return, even from US shares, going forward from today is very similar to that you should expect from Australian shares. At first this may seem counter-intuitive but with the free-flow of capital and efficient markets then if higher returns could reasonably be expected from say Australian markets than US markets then global hedge-fund managers would be selling US shares today and buying Australian shares. Prices would immediately adjust until the expected future returns were similar (ie. Australian shares prices move up and US share prices move down.) The flow of capital and price movements should happen immediately upon the release of new information about the respective economies.

All of this translates to the fact that our current strategy is sound. The last financial year, whilst not being outstanding, was almost exactly what you should expect over the long term from this type of investment portfolio. Return for growth portfolios was around 14% with small companies doing better than large companies, emerging markets doing better than developed etc. There was a slight negative effect due to Australian dollar movement.

I hope that this all makes sense.

Feedback welcome!