Monday 27 October 2008

A graph I wish I'd plotted a year ago


I've been trying to find some empirical evidence to support my hope that the current bear market is already "overdone" and we must surely be close to the mythical "bottom". I was thinking that now the market is back down to where it was four years ago it must be getting below "fair value" - after all, it wasn't considered to be too excessively priced in 2004, having just started to recover after the bust of the dot-con bubble. And since then the Australian economy has experienced continuous economic expansion. With the current view that Australia is liable to suffer an economic soft landing rather than a recession, that would mean that the listed companies (which are, after all, a large chunk of the economy) must be worth a bit more than they were four years ago.

Unfortunately (for my current peace of mind) I then looked up the stats on Australia's GDP (gross domestic product) and the ASX200 Index since the 1970's. As you can see from the graph below, all it shows is that the stock prices did get vastly inflated compared to the value of the underlying economy during the past decade, and the recent 45% decline has only now brought it back in line with it's "normal" ratio to the value of the Australian economy (GDP). I had a feeling during 2007 that the bull market had gone on for a bit too long, and considered either taking some profits or "insuring" my portfolio via Index Put Options. In the end I bought some put options that expired in Dec '07 but then didn't replace them with new ones! If I'd had this chart to hand last December I would have made sure I kept my portfolio insurance in place for another year. It's nice to say "live and learn", but I suspect that this is one lesson I've learned a little bit too late to be of any use.



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6 comments:

Anonymous said...

It's very refreshing the honestly and openess with which you talk of your portfolio and how the recent downturns has taken its chunk.

Trading on leverage is a double edged sword and I'd say many people will be sitting on the sidelines for many years to come as a result of the punishment their portfolio's have taken recently.

I hope for your sake your portfolio bounces back but reducing some of the leverage pressure might be in order as well.

Good luck.

mOOm said...

Interesting chart. On the other hand, interest rates recently have been lower than in the past which justified higher valuations, and it's possible for the top 200 listed companies to grow relative to the rest of the economy for a while (though not forever).

Anonymous said...

Hi

Your comparative graph was excellent!

Can you post up the URLs to where you obtained your historical data for Australia's GDP and the S&P 200.

Im keen to keep an eye on the data going forward.

Many thanks in advance!!

enoughwealth@yahoo.com said...

data sourced from

http://www.economagic.com/aus.htm

Moom has a good point about share prices also tending to be higher when interest rates are lower. In the early 90s I used to plot some relationship between the market's monthly average p/e ratio, the inflation rate and the cash rate. The idea was that although it's hard to time the market, it is possible to spot when the market has been oversold. I was hoping to improve performance by dynamically 'tweaking' my dollar-cost averaging investment program. After a while I gave up on that project as the monthly data became hard to obtain for free.

Anonymous said...

wow! That is a very interesting relationship. Statistically, that would make sense although I find it interesting that shares have not been significantly oversold in that period. Did you try the All Ords to see if there was any significant difference (unlikely but still interesting...)

seanhecking said...

great post! this chart is very helpful. it looks like when ever we dip below, it's time to buy!