Wry & Dry

Meanwhile, the markets melts

Not even the thought of a holiday tomorrow could soften the blow of the share-market's dismal September quarter.  Like wolves on the fold [1], three factors gave the share-market a whiff of, well, panic.  The All Ordinaries Index returned -7.2%, or -5.8% with dividends.  More pain than a dinner date with Bronwyn Bishop.  

Okay, first things first.  And showing bias toward First Samuel clients - whose shares returned an average of +1% (before fees) for the quarter (nice work) - this week's Investment Matters section, below, from First Samuel's CIO Dennison Hambling, speaks of the value of patience in investing.  Live well. Sleep well.

Now, back to the markets.  And it wasn't just about Glencore (see more below) and Volkswagon (not really relevant, yet).  The chart shows where the pain was amongst the 20 Leaders (i.e. the 20 largest stocks on the ASX).

The bigger they are

What has happened is that the market was over-valued, principally because of the faintly ridiculous 'search for yield', also know as the Lemmings-Over-The-CBA-Cliff approach.  This drove up the share prices of many larger stocks that paid high and seemingly better dividends.  And the frenzy got so much that the banks, for example, were undertaking capital raisings, those 'hybrid issues', partially so they could keep on paying out increasing dividends.  A faintly absurd [insert your adjectival noun here] scheme. 

Then a few things happened...

1.  Investors began to realise that the market was over-valued (i.e. at a P/E of 16, the market was about 10% over-valued versus its long-term average).

2.  To compound this, the Chief Tellers at the major banks realised that APRA (the regulator) was serious when it said the banks needed more capital.  More capital means more shares.  More shares with the same expected profit means that profit (or earnings) per share will go down.  Hence the shares are less valuable, and their price goes down.

3.  To compound this, someone in China put on the handbrake.

So, with all these prices falls, has the market become any more attractive?  Well not really, because:

4.  The profit (aka earnings) outlook for Australian companies began to diminish, so the E (Earnings in P/E) went down almost as much as the P (Price) went down.  Year 5 maths will tell you that if the numerator (top line) and denominator (bottom line) both change the same, then the outcome (P/E) will be unchanged.  So the market P/E, at about 15.3, is only a little changed.  And still over-valued. 

The share-market result?  Consecutive negative quarterly returns from the share-market.  The chart below is a little generous, as it shows the quarterly performance of the All Ordinaries Accumulation Index (i.e. including dividends).

Successive negative Q

So what does this mean for investors?  First Samuel's CIO, Dennison Hambling, nails this in Investment Matters, below.