Financial Stability Snapshot 14 October 2016
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Australia & Canada’s experience with equal weighted indices
Correction to my earlier post. Equal-weighted indices don’t always outperform cap-weighted indices, as with the S&P 500. Australia’s ASX 100 Equal Weighted Index underperformed the cap-weighted ASX 100, recording annual growth of 3.79% (EWI) compared to 5.28% for the ASX 100 on a total return basis over the last 10 years.
Canada’s TSX 60 Equal Weighted Index, on the other hand, mimics the S&P 500. Equal Weight achieved an returns of 6.17% over the last 10 years compared to 5.33% for the cap-weighted index.
I will investigate further why Australia bucks the trend but I suspect the banks play a major role. The ASX 300 Banks Index substantially outperforms the broad ASX 300 Index.
Active managers and Index funds: How to avoid the pitfalls and get the best of both worlds
From James Kirby at The Australian:
Australia’s big fund managers are now openly bagging index funds and exchange traded funds (ETFs)….Keep away from index funds and ETFs, they cry, the market is too tough for investors to blindly follow an index-style fund when returns are as modest as we have seen in recent times….
But rather than flinging mud back at the active managers…. the passive brigade has instead made two killer moves.
The first move is to reveal quite plainly how the active managers are performing — and they are performing dismally.
The second move is to continually cut prices — or fees — to the point that active managers look very expensive indeed.
Dow Jones’ Indices versus Active Australia Scorecard:
Australian General Equity (Large-Cap) Funds
59.7% underperformed the S&P/ASX 200 Index over one year
69.2% underperformed the benchmark in a five-year period
International Equity General
80.7% underperformed the S&P Developed ex-Australia Large Cap Index in a one-year period
91.9% underperformed the benchmark in a five-year period
I have two major concerns with index funds:
First, index funds reward size, not performance. The bigger a corporation grows, and the bigger its weighting in the index, the more stock an index fund will buy. Over time the index is likely to grow increasingly dominated by a herd of dinosaurs — earning low returns on a large asset pool and unable/unlikely to adapt to change — headed for extinction.
Second, active fund managers perform a valuable role for the entire market, conducting in-depth research of industries, visiting companies and evaluating prospects and performance. Their resulting purchases and sales inform the entire market as to prospective value and under-pin long-term market value. Increasing dominance of passive index funds erodes this capability and will hasten the growth of my first concern.
An easy way to counter the first concern is to invest in equal-weighted index funds. These do not reward size, instead investing an equal amount in each stock in the index instead of weighting by market capitalization.
Apart from eliminating the size bias, the equal-weighted index has another major advantage. It out-performs cap-weighted indices by a sizable margin. The graph below shows the S&P 500 Equal-Weighted Index achieved an annual performance of 8.53% compared to 7.03% for the regular S&P 500 Index, over the last 10 years.
The only way to address the second concern is to keep a sizable part of your portfolio with active managers. Don’t blindly follow performance — last year’s winners are often this year’s losers — but follow managers with reasonable fees and proven long-term ability to outperform the index.
ASX 200 stalls
Two short weekly candlesticks suggest the ASX 200 rally has stalled at 5500. Bearish divergence on Twiggs Money Flow warns of selling pressure. Reversal below the lower trend channel would warn of a test of primary support at 5000/5100. Breakout above 5600 is unlikely.
The ASX 300 Banks Index is testing resistance at 8000. Declining Twiggs Money Flow still warns of selling pressure. Breakout above 8000 would signal a primary up-trend but I would be cautious and wait for retracement to respect the new support level. There are some good fundamental reasons, like the real estate/apartment bubble, that suggest a reversal would be premature.
Government aims for wrong target on debt | MacroBusiness
Macrobusiness quotes LF Economics’ submission to the House of Representatives Budget Savings (Omnibus) Bill 2016:
….It is critical policymakers reign in exponentially-growing private sector debts as this consists of a major source of future financial instability. Australia’s household debt to GDP ratio is the highest in the world, at 125% and rising. Ironically, by ignoring private debt expansion which has generated a housing bubble, public debt will inevitably rise to stimulate the economy to counteract the economic downturn when it bursts.
Source: Government aims for wrong target on debt – MacroBusiness
Kevin Andrews and the challenges for Australian conservatism
By William Hill:
The Liberals …have to decide how to confront the anti-business, anti-immigration trend that is developing on their right flank.
John Howard was able to manage One Nation by moderating his criticism and by appearing to assuage some of their concerns. On the BBC Howard responded to a criticism of his refugee policy by arguing that the handling of the former helped to mitigate opposition to orderly migration.
Concerns are real and perceived but the economic insecurity confronting so many Australians and their children is a palpable thing. Some people voice their frustration by voting for a moderate protectionist such as Nick Xenophon and others hitch themselves to One Nation’s more assertive and aggressive style. The Liberals are in difficulty when so many of its natural voters are suspicious of capitalism and the importation of more and more people into the country.
……The supporters of Hanson, Xenophon, Lambie and Katter do not feel that the present arrangements in parliament are working for them and we should not rush to dismiss them. We should also give these voters the benefit of the doubt that they do not share the faults and naiveties of the people they have elected. Andrews advocates a more conciliatory approach when it comes to Hanson’s supporters:
“You have to listen to their concerns, the fact that a person votes for One Nation doesn’t mean that they are a racist, redneck, homophobic whatever. Some might be but usually there is an underlying concern about the direction of the country and the direction of the economy that’s motivating them.”
That underlying concern is nothing less than their fear for their economic wellbeing and that of the next generation. If the Liberal Party is going to defend free enterprise, free trade and immigration against protectionists and nationalists then it had better do as Howard did successfully and give the concerns of the latter fair hearing.
Australian banks rally
The ASX 200 is headed for another test of resistance at 5600. Bearish divergence on Twiggs Money Flow warns of selling pressure. Breakout above 5600 is unlikely and breach of the lower trend channel would warn of a test of primary support at 5000/5100.
* Target calculation: 5400 + ( 5400 – 5100 ) = 5700
The ASX 300 Banks Index formed a bullish higher trough above 7200 and is again testing resistance at 8000. Declining Twiggs Money Flow, however, warns of selling pressure. Respect of resistance remains likely. Breakout, however, would signal a primary up-trend.
TPG shares drop more than 20 per cent on disappointing forecast
From Lucy Battersby:
The market has fallen out of love with telco company TPG….
The cut-price telco beat guidance by just $300,000 when it has a history of beating guidance by tens of millions of dollars.
It has also forecast earnings growth of 7 per cent this year, the lowest growth forecast in seven years.The reasons for the soft result include plans for more capital expenditure than usual, its future profit margins are likely to be squeezed on the NBN, and there are few obvious acquisitions left after swallowing up iiNet and AAPT in recent years…..
Source: TPG shares drop more than 20 per cent on disappointing forecast
Opportunities in Australian banks | Franklin Templeton
Alastair Hunter – Lead Analyst, Investment Manager | Franklin Local Asset Management
Australia: ASX 200 weak but support for banks
The ASX 200 penetrated its lower trend channel, indicating that the up-trend is slowing. This week’s long tail indicates short-term buying pressure but not necessarily a reversal. Breach of primary support at 5100 would warn of another decline (4700). Bearish divergence on Twiggs Money Flow indicates long-term selling pressure.
The ASX 300 Banks Index is consolidating between 7200 and 8000. Declining Twiggs Money Flow peaks warn of long-term selling pressure but this week’s blue candle suggests short-term support. A test of primary support at 7200 remains more likely but a failed swing that recovers to 8000 would be a bullish sign. Breakout above 8000 (still unlikely) would signal a primary up-trend.
