Recent advances in stock markets are pointing to a brighter future, reflecting improvements in the US economic outlook. But are we really basing expectations on solid fundamentals, perhaps treading on thin ice? Markets reflect recent volatility, yet the fear factor is declining. Where are we heading?
Ever since the collapse of Lehman Brothers in late 2008, the global market outlook has been unclear as the developed world is still struggling to recover. Investment trends have not played out the way they used to, inasmuch as fundamentals no longer take markets where they are expected. Sometimes markets do exactly the opposite of the expectations.
When I look at how markets have responded to certain indicators in recent history, my conclusions point to a number of different potential outcomes from recent history. One example was the release of US unemployment figures. The results were far from encouraging and yet markets gained. Prior to 2008 this was almost unheard of.
I recently came across some interesting statistics (see table) from the US, comparing October, 2007, and March, 2013, the two months when the Dow Jones Industrial Average breached 14,000 points. What conclusions can we draw from the comparisons?
The Dow has now breached 14,500 and the Nikkei 225 has soared by more than 40% in the past four months. These are remarkable statistics when you compare the state of many economies in the world with the shape they were in just five years ago. Since the collapse of 2008 we have experienced the lowest central bank interest rates in history, in an attempt to stop global economies from spiralling down into the abyss of deflation.
So what does all this mean for expats and their wealth? If you had sat tight during the 2008-09 recession with capital that you did not wish to use for more than five years, the US equity market would have brought you back to a position where your portfolio had a compounded growth rate of 2.8% per year since the peaks of 2008. That certainly would have beaten the bank. Had you invested into the US market at the floor level of March 2009, the gains would have been a huge 15.8% per year compounded since then.
Volatility has recently been high. The Dow Jones has made some sharp declines over the past couple of months with almost immediate recoveries. As recently as Feb 20 the index dropped 100 points because the Fed expressed some jitters about interest rates; a sharp recovery pulled the index back, but the following day there was a 200-point decline when the Italian election produced no clear winner. The market clawed back over the following two trading days, pushing the index to a new all-time high.
The last time we saw volatility of such magnitude, it was a prelude to some sharp declines in all global bourses. We have now seen the UK downgraded from AAA to AA+. This has weakened sterling and frustrated many expats in Thailand because they get fewer baht for the pound. The outlook points to a triple-dip recession in the UK, with the anticipation of more announcements yet to come. Are these indications of a further possible decline in market values?
Some schools of thought say not necessarily so. When markets collapsed in 2008 it was mainly because of private debt, chiefly the subprime mortgage crisis. This all related to mortgage debt and the fact that much had been wrapped up in unrecognisable packages of investment derivatives. Many substantial financial institutions had purchased huge amounts of these apparently safe investments. Once the extent of the damage began to emerge, the entire world was caught up in this crisis.
One of the differences we see these days is that the current problems seem to relate to economies and sovereign debt rather than private debt. Governments are now deep in the crises that surround us. Who would have dreamed in 2008 that the US or UK could ever have been downgraded from AAA status?
Once upon a time, government bonds were totally risk free. They paid a dividend and were a safe investment with a relatively low return. These days they still produce relatively low returns, but are now considered nowhere near as safe as they once were. European central bank bonds are now far more risky because the governments that issue them are known to be in economic turmoil. The returns have improved but, like all things, the risk has increased.
Similarly, at one stage the safest place for any investor was the totally risk-free bank deposit. Then along came Lehman, Bear Stearns, the Icelandic banks, and now banks are no longer considered as safe as they were. If you have deposits in a bank in Cyprus you are among the latest wave of those who've experienced the uncertainty of a "safe bank deposit".
I meet many expats who are really unsure about what to do with their valuable savings. Many are sceptical about the different options available. It is true there are plenty of options but you need to be careful how you choose.
If you needed a medical operation would you do it yourself or leave it to your friend or relative because they talk knowledgeably? We all know that would be a stupid thing to attempt. However, we are moving in that general direction. Many people today see a doctor and are told they have something specific. The first thing some do is research the condition on the internet and then they are frightened out of their lives by the threats that seem to loom.
Others seek counsel from a financial adviser and when he recommends something they go online and find a horror story about what might go wrong. The adviser gets blamed and is unnecessarily tarnished.
Two years ago a senior person in the Financial Services Authority in the UK made a statement that all life settlement funds were toxic and dangerous. There was a stampede to exit all such funds and turmoil ensued. The fact was that some of these funds were very sound and still are. These are just some examples of how a panic can easily spread.
We seem to have been through a paradigm shift in the way we approach the world in a number of different facets. Most of these changes are good but sometimes we make things dangerous for ourselves.
Markets as well are trying to embrace change and it may take a while before they have success.
Andrew Wood has been an expat in Asia for 33 years and is executive director of PFS International. His articles, which cover the complete A-Z of financial planning, are available through the PFS library to readers on request. Questions to the author can be directed to PFS International on 02-653-1971 or emailed to enquiriesthailand@fsplatinum.com.