May 19, 2018
This is a question that was brought up recently.
Given a lot of my investing is based in Australia, this is clearly a concern. I did answer this question very simply over on Reddit but it deserves its own article.
It’s important, not only for sharemarket investors, but property investors too. For some reason, only the sharemarket investors seem to get worried about being invested in Australia only…property investors seem more than comfortable with this position.
Back to the question. Here are some of my views on this topic.
It will. I can guarantee at some point it will.
That’s just what happens from time to time. When it happens is anyone’s guess. The truth is nobody knows. And if we try to be clever and think we know when it’s coming, we’re just fooling ourselves.
First off, usually our sharemarket crashes because the US/global markets have crashed. So investing elsewhere may or may not make much difference.
The global economy still takes their lead from the US. As the saying goes “when America sneezes, the world catches a cold.”
I believe this is true more than ever, with the addition of China. Due to global trade, we’re more inter-connected than ever, so we all rely on each other to some extent. Obviously, smaller countries like Australia rely on these global giants not ‘catching a cold’.
See this related study from Vanguard, highlighting the correlations between different countries’ stockmarkets. They found that a recession and bear market (defined as a 20% fall or more) in US stocks, tends to correlate with a fall in other developed markets (that’s us), more than 70% of the time.
Although we can’t be sure of when a downturn will occur, we can get some hints.
Here’s a helpful chart showing Annual Total Returns for Australian Shares, going back to 1900, including dividends. The figures are by calendar year and show that big downturns in stocks normally come after periods of out-sized returns. (the share price decline from top to bottom is not measured here as it’s just year-by-year returns.)
Some of the worst periods were as follows:-
1929-30: shares returned -31% over two years.
In the 11 years leading up to this decline, shares had returned 475%. Yes, you read that right! That’s a return of 17.2% per annum.
1973-74: shares returned -44% over two years.
In the 6 years leading up to this decline, shares had returned 157%. That’s a return of 17% per annum.
2008: shares returned -40% over the year.
In the 5 years leading up to this decline, shares had returned 164%. That’s a return of 21.4% per annum.
So I’m not surprised these crashes occurred. When returns are as high as that, it simply can’t continue forever.
For investors focused on income, this means if we’re retired during a period of unusually strong dividend increases, we should strive to simply save some of it by not spending all that extra cash. Any increase above inflation can be thought of as a bonus, to be re-invested into the portfolio. Or if you’re feeling more cautious, added to the rainy-day savings account.
Just as it is with our everyday cashflow, if we save some surplus when times are good, we’ll have more tucked away for the not-so-good times.
According to the chart of annual returns, there’s no period of more than 2 years in the red.
I had to check that again for myself, because it’s quite surprising.
Most of us tend to think of a ‘downturn’ lasting for many, many years. What’s more likely, is the psychological affects hang around long after the bad times have passed.
It doesn’t help that many are obsessed with share prices and like to point out the dramatic top-to-bottom decline, while ignoring dividends. Or the fact that nobody invests all their money in one day at the very top of the market!
Personally, I don’t see the need to ‘prepare for the worst’, meaning plan for 10 years of negative returns.
The reason I focus on the dividend income from shares is, it’s based on how much companies are earning, which is more in line with how the economy is doing, and not how popular the stockmarket is, as measured by share prices.
Dividends don’t fall anywhere near as much as share prices during a downturn, which is valuable in helping investors stick with their long term investment plan.
We’ve only had a handful of big declines over the last 120 years. The US has been very similar. We each have our turn, experiencing bigger booms and busts through the cycles.
A good article comparing the ups and downs of both markets, as well as returns going back to 1900, can be found here.
Australia recovered much faster during the Great Depression of the 1930s, because we didn’t have such a large speculative boom like the US did. It tends to be – the larger the boom, the worse the crash.
So many discussions around sharemarket crashes seem to be based around the Japanese situation, where their economy has supposedly struggled since their almighty bubble popped in 1990.
Prices for stocks and real estate got to levels nothing short of insane and are mostly still below those prices today.
On top of this, Japan’s working-age population is shrinking, now making it harder to grow their economy.
As the rest of the world has seen this play out, most countries will do just about anything to avoid becoming Japan!
In Australia, our working-age population is growing strongly, faster than other developed nations. And this bodes well for economic growth. Also, our population is becoming more urbanised, which tends to make us more productive, boosting economic growth and leading to higher prosperity.
But despite some of the horror stories, here’s an interesting article on the misnomers about Japan’s economy and stockmarket. It seems many assumptions are incorrect.
Company profits have actually been growing at a solid rate since at least 1997, only 7 years after the collapse. And Japan has actually been one of the best places since the GFC, for dividend growth.
Bottom line: Australia is not Japan, and I think it’s extremely unlikely we experience anything like their infamous bubble. Also, the economic and corporate performance is nowhere near as bad as it’s made out to be.
Despite the doomsday comparisons, Japan’s companies are still growing their earnings and dividends for shareholders.
I dive into this topic heavily in my interview with Pete Wargent here: The Future Of Australia’s Economy.
OK, let’s say we have a big collapse and for some reason it lasts for a decade or more. Let’s say the Government and RBA does nothing to improve the situation. What investments would save us?
Well, investing in property won’t help. Property would most likely crash too, in a scenario that bad. Without jobs, people wouldn’t be able to buy houses and many won’t be able to pay rent.
If this ran on for long enough, it would be basically widespread starvation. We’d probably have breadlines and may even need international aid.
Depending on your outlook, perhaps there’s a good case to be made for buying baked beans and bitcoin. But for most investors, adding international shares to their portfolio should help to alleviate this worry.
For me, I think this scenario is far less likely in the future than it was in the past.
As the GFC was unfolding, it was declared capitalism is dead. Apparently, the world as we knew it was over. But now, a decade on, we can see that life is pretty much the same as before.
Capitalism simply morphs into a new version of itself over time, and has done this throughout history.
In the olden days, economies were basically left to languish and recover by themselves. But these days, the Central Banks and Governments will do pretty much anything to stop that from happening.
It’s far too painful to have mass unemployment, companies collapsing and surging bankruptcies.
Nowadays, economic cycles are now longer, recessions are fewer and smaller – in no small part to the work that the Reserve Bank of Australia (RBA), and to a lesser extent the Government, does to manage the economy.
I know it’s popular, or even cool, to hate on these institutions, but I think they do a reasonable job.
Although it’s certainly true, we’re very lucky in Australia, having mostly avoided the GFC. In fact, we currently hold the world record for the longest period of economic growth, 27 years and counting, without a recession!
Anyway, these global overlords have been coming to the rescue in a bigger way, each time there’s a hiccup in the global economy. Whether right or wrong, they now see it as their duty to step in and pump up the economy at all costs. And it’s more or less worked well.
The best modern example is in the US during the GFC, where the government and Federal Reserve (their central bank) stepped in with bank-bailouts and stimulus, amounting to trillions of dollars over the years that followed.
Luckily we didn’t need to go to that extent, as our economy recovered rather quickly. But it goes to show you the level that governments and authorities will now go to, to avoid the economy sinking into a depression. (it was suggested that if nothing was done in 2008, the global economy would collapse because our financial markets are so interconnected)
Although Australia didn’t have a major economic meltdown in the GFC, the Government still gave us $800 cheques to try and stimulate the economy with spending. Remember that?
They were so frightened we’d fall into recession, they actually gave us money to spend! This is called helicopter money!
Since our government debt is relatively low, compared to other nations, we arguably have more spending-power to pull ourselves out of the next recession. Hopefully this gives us the ability to avoid a long-lasting downturn.
Maybe I’m a delusional optimist. But the world seems to be getting wealthier and better managed all the time.
There’s always things to worry about, dodgy tactics from high-powered people and bad stuff to point our finger at. We actually have to go out of our way to find all the positive changes occurring in the world.
The way economies are managed in modern-day capitalism means Governments and Central Banks will do whatever is necessary to minimise the damage of recessions and crises. Some have even stated this ‘whatever is necessary’ message to the public.
After all, what’s the alternative?
For all the ups and downs of the economy over the past 100 years, we’re far wealthier as a country, and individually, despite the inevitable wobble along the way…
To paraphrase a book title, feel the fear and invest anyway!
And given there has never been a period of more than 2 years in a row of negative sharemarket returns, I don’t feel the need to build a decade-long economic decline into our future planning.
In general, the more you try to create a bulletproof scenario for yourself, the longer it’s going to take to become Financially Independent.
Related post: Long Term Investing & Shrugging Off Sharemarket Falls.
I’m not saying nothing bad will ever happen. We know from history it’s bound to, at some point.
But history also suggests it pays to be relatively optimistic, since the progress of humanity and increasing prosperity means our living standards keep improving in ways we can’t imagine.
Essentially, I’m pointing out that it probably won’t be as bad as many fear. And the notion of a multi-decade decline or stagnation for Australia seems incredibly unlikely for the reasons stated. Granted, there’s always people who think otherwise, and they should invest accordingly.
In my view, a downturn is only likely to last a few years as they typically have in the past.
But in any case, we go on living. People still need to buy food and use services. So most of Australia’s companies will continue to make profits.
Society simply won’t function if corporate Australia goes into permanent decline. And that wouldn’t be a society you’d even want to live in!
Most importantly, as early retirees, there’s heaps of things we can do to see our way through a downturn which I’ll get into another day.
Now, enough of this scary talk. Let’s keep investing!