My ramble on the property market, the banks, APRA, index investing, market timing and diversification.

Ok so you probably gathered I am experimenting with a bit of click bait.

I am also curious to see if all the keyword tags will see increased traffic on the blog. If I see some clicks on this blog (it doesn’t normally get many views!) maybe we do have a serious boom! This may be possibly followed by some hate mail from property investors as I express some caution on prices in Sydney and Melbourne. I firstly admit I have zero credibility as I have underestimated, and not taken full advantage of the property boom we have seen.

As I have recently taken a closer look at some of the older domestic LICs in the market that hug the index to an extent, I was a little surprised the extent of holdings in the major banks. I had a rough figure in my mind what the major banks may make up of the index but it was lower than I realised. From what I understand we are not far of 30% for the four major banks alone, I am not counting other banks and financials here.

I then began to ponder about how in the early 1980s the Australian share market had a huge exposure to the resources sector, which was not where you wanted to be for almost the next couple of decades. Around the peak of the tech bubble News Corp was a huge part of the index, where some fund managers were getting hired or fired based on getting this call correct. The company was bid up so much from funds giving up on picking the direction of News Corp and just following the index. You would just buy it and be market weight and let your other calls decide your fate. I wonder if some of the strength in banks lately is related to this line of thinking.

Another reason for the strength may be the out of RBA cycle rate rises potentially enhancing margins. There is probably some merit to this thinking. I would caution too much excitement though, as the pressure applied from APRA has opened an opportunity for non-bank lenders who don’t face the same scrutiny from the regulator. It may have transferred plenty of customers away from the major banks, and perhaps they will stay away. Then again many get the feeling it has been a bit of a furphy anyway, suggesting that there are ways around the banks to keep growing investor lending above the targets that APRA frowns upon.

My feeling is that the Australian economy may face some pressures building up soon that are not being discussed that widely right now. High property prices in the two major capital cities in my opinion will not boost consumer confidence, but rather do the opposite. Many boomers now see it as a negative on behalf of their kids / grandkids, Gen X see it as a negative if they aspire to upsize and we know what the younger generation think. This is a major shift from when prices rose dramatically circa 1998-2003, it then provided boosts to confidence and spending. I just see it now as a dent to the consumer’s spending power having to take on bigger mortgages. If you subscribe to the theory some of the price pressure is being fed from China after large price rises in their major cities, I’m also uncertain how that translates to improved consumer confidence in Australia. Also, the major banks are raising rates led by pressure from APRA. The pressure from APRA also extends to property developers, meaning the construction sector could be in for a serious slowdown. Despite some predicting a RBA hike this year, I can see a soft construction and retail sector and the RBA can wipe its hands of the property boom issue. They can point to APRA being the best way to target it, and saying it is confined to Melbourne and Sydney. The relief valve for the economy may have to come from a declining AUD.

As I have proved when blogging it can be a mug’s game when trying to capitalize on these macro issues, so why do I bother? The answer in my case is about diversification and minimizing drawdowns, not trying to time the market. I don’t advocate shorting the banks in Australia which has been a widow maker trade for hedge funds in the last decade or more. The point I am trying to make is we can largely stay invested in the market and capture most of its “beta”, without having to be too concentrated on certain themes and going near potential bubbles. There are enough stocks in different markets in the world to avoid areas that you may think potentially show signs of being overheated.

This is a complete harry hindsight comment but I would argue it should have been a relatively easy decision to have not owned Japanese shares in the late 80s, or US “new economy” shares in the late 90s. That didn’t mean you had to time the market. It just meant noting extreme valuations may spell trouble, and to direct your attention to other stock markets or sectors. The old “time in the market” adage does not require you must have all your savings in one market, where an ETF may give you four very similar stocks in the same sector totalling 30% of your investments.

I bring this up as I see a love affair going on with index investing right now. I am a huge believer in passive investing for most people I just believe it should be given a bit more context when it is discussed. I see discussion threads about Australians stretching themselves to get their first home and do the hard yards to free up a bit of equity and establish a line of credit. Then they “diversify” into a different property on the coast or interstate. The next diversification may be some ETFs and old fashioned LICs full of bank stocks. As this works out well why not diversify into some direct bank shares for the yield. As this works well why not diversify into their hybrids. They may come up with the idea on their way to their work, for the bank. Perhaps a slight exaggeration but you get the picture. At the end of the day they probably just want the double-digit growth that the share markets seem to have delivered in the US and Australia the last century.

We only know with hindsight that these were two of the great countries to invest in at the beginning of the 20th century. For someone starting to invest early in their career now, do we really know this continues for the next 50 years? It probably will I hear you say, and I probably agree. I mentioned Japan before as a recent example of a major country having a disastrous experience for investors. Russia and China have been examples I believe where the entire stock markets have amounted to nothing at different points in the last century. Germany is not exactly a small country either where your shares would have been painful to hold during hyperinflation. The huge drawdown in US shares after the Great Depression is also well documented.

A long while back we probably had excuses not to diversify. Which brokers could we use for offshore markets and at what cost? These excuses are clearly lacking now with the internet, global access, and huge ETF market.

Getting back to my points about saying Japan in the late 80s and US tech stocks in the late 90s showed some clear signs of exuberance and worrying valuations, where should we be concerned now? In virtually every valuation method the US share market is looking stretched. As usual, there are excuses why it’s different this time, and many of the excuses I honestly think sometimes sound reasonable. I just feel there are enough warning signs to largely avoid this market. I’m not saying to go 100% cash, but to look elsewhere in the world. In some ways, I am going against Warren Buffett’s recent reiteration of his suggestion for most people to go with a 90/10 approach, being 90% in a passive US equities ETF fund and 10% in bonds. That may get me some more hate mail also. I believe the US market may be hitting 30 on the CAPE ratio. Why not perhaps consider broadening this passive investing approach to Europe, Asia and Emerging markets where the CAPE is maybe half of that. You may be surprised to the extent that valuations can drive future returns rather than your perception about where the economy may head in the future. (Read the link I provide further down if you doubt that). I personally think these currencies also stand a good chance of outperforming the AUD in the future.

I don’t like currency “risk” I hear you say? In 2008, owning some equity exposure outside of Australia didn’t feel as risky when the AUD was collapsing compared to Australian shares.

What other asset classes may be risky, and that we can search elsewhere for our “beta” rather than time the markets? Well readers may well be living in it. My initial headline might have been tongue in cheek, but it is not that far off some of the news stories I have seen from property moguls aged in their 20s of late. It is hard to predict the top and I am not trying to (I’ve tried and failed before like most!). I just believe more Australians would be better served by broadening their horizon when thinking about investment opportunities. Many seem to take the approach it must be to either buy an investment property yes or no, or leverage into bank shares yes or no. When I started to have an interest in shares we paid 2.5% brokerage, maybe even some stamp duty, and had to ring up from the landline. We have far more investing alternatives open to us now but it seems many are stuck in the past with their way of thinking.

Now you may rightly point out what would I know? This is just a ramble with no evidence of support. Well here is a link with some data and pretty coloured numbers. Not my work, it is from Meb Faber who I have recommended his books and podcasts here before. Some of the charts and data towards the end may lead you to think more about where are the cheapest markets in the world today, rather than limiting ourselves to an ASX ETF with a huge exposure to banks or the US market. Here is the link, I think it is a very good read and may challenge a lot of what you have read elsewhere concerning the debate of timing the market or “time in the market.”


  1. Hi Steve,

    Great thought provoking article.

    A couple of useful links relevant to your article which you no doubt are probably already aware of. I have found the topic of CAPE to be a very interesting one:

    If taking a more active approach the Faber CAPE approach shows a look of promise.

    Then you get the somewhat more passive approach by Carlson in this article based on the view that nobody really knows:

    Trouble is as a retiree dividend investor I find it hard to change my approach. Maybe I’m getting older and more stubborn. Perhaps stupid and lazy needs also to be added to the list.

    Every now and then I look at our investments and ask what if a Japan type scenario happened to the Australian market. Fortunately we would still be fine Income wise, many of course would not. But I still like to reduce risk somewhat with diversification outside the ASX top 20 (active mid / small cap) and have International diversification both passive and active. Very importantly the majority of buying is done in times of gloom. Buying during periods of high to extreme valuation is dangerous at worst or a severe drag on wealth creation at best hence it’s something I try to avoid.

    Although not without its flaws this article by Ashley Owen highlights the dangers:

    This from one of Owen’s other articles sums it up nicely:
    “If all you do is ignore the herd and avoid buying in booms and avoid selling in busts, then you are avoiding the two most dangerous wealth destruction zones, and you are still going to be better off than probably 90% of investors and fund managers in the market. ”

    None of this will be new to you I imagine but it’s the sort of stuff I read to try to figure out how I can deal with some of the issues you raise but importantly still gives ME good SANF.

    In my case rather then venture into some perceived riskier International markets exhibiting a favourable CAPE valuation that I feel uncomfortable with I tend to stick with those markets that let me sleep well at night BUT wait patiently for buying opportunities in times of gloom. Unfortunately the wait can be long at times and not everyone is fortunate to be in a position like us to do so.

    Keep up the great work, you have an excellent blog.


    1. Thanks for commenting Austing and providing some great links there. I have referred to the star capital site quite a lot myself in the past. I enjoyed reading all the links. The one from Carlson I could relate with a lot, which is why I try to have a rebalancing discipline between some asset classes. As the article suggests everything fluctuates a lot and who really has a clue? I often implement some marginal tilts with my views but keep that quite small. The other article I agree that 5-10 years is not a long time frame in the markets, and too short to draw major conclusions from. Yet the media is constantly saying you can hold onto your blue chips and in 5 years everything will always be ok.

      Clearly you have given the issue of diversification and the downside to the dividend income a lot of thought which is half the battle. The issue probably becomes more complicated if one is sitting on large capital gains. Also I understand that the franking credits benefits that go with sticking to the Australian market are certainly worth something.

      I am wondering what some of the old LICs will do if the banks outperform strongly over the next few years and make up over 35% of the ASX200? I suspect they will not want to crystallise tax and the likes of AFIC will not want to trade their sizeable holdings. They could still be good LICs to use as part of your strategy but many will not appreciate the concentration risk they may be taking. I saw an article on the net from late last year implying AFIC can be a set and forget stock for your whole investment portfolio. It made no mention of the total exposure to the four major banks. Also how would some old style LICs market themselves in that scenario? Would they really be value based investors running an active portfolio management strategy? Will the barefoot investor in the hearald sun continue to advise to put all your sharemarket money in them, compare them to Berkshire Hathaway, and be downbeat on property at the same time? Will the funds management industry see how concentrated the popular ASX200 benchmark becomes and start to manage to a more customised one? If so there would need to be some position changes to many portfolios, that may not be kind to the banks.

      Other factors that I didn’t bring up that come under the diversification decision are government policy. This may also be a little under appreciated with many investors. Often people go into a strategy 100%. For example all into negative gearing property, or all into targeting franked dividends, or all into the tax benefits of the superannuation system from a young age, or as much wealth as we can to a CGT free main residence. Choosing one focus could result in being exposed to a significant change in government policy in these areas.

  2. Trying to future proof ones portfolio is damn difficult and at times scary.

    Another article by Carlson which I think you may have seen on the PC forum gave a taste of what Bernstein covered in his book Deep Risk. It really highlighted home bias risk:

    It doesn’t help SANF when one reads some of these articles. Hopefully the Nuke scenario doesn’t eventuate.

    Getting back to the traditional LICs you raise some great points. I have sizable exposure across the older LICs and this does concern me at times. Because of their desire to keep the LIC Capital Gains Tax Status with ATO they need to keep their turnover well below 10%. Unfortunately this results in a weakness on the sell side discipline. And of late they also seem to be late to the party with market trends eg small caps.

    Then again their snail like approach has kept them out of trouble in the past. And their past is considerable. But will this work with the increasing rate of change and disruption in the world nowadays?

    Ok we can go completely passive with Index ETFs. Given their rules structural changes should be reflected in the Index constituents. Unfortunately so to is irrational exuberance and fads. There is no way of avoiding the bad. The traditional LICs can!

    That then leaves more aggressive active management. With “trading” LICs this will mean that discounted CGT is not allowed. But in many cases it’s a price worth paying to manage risk and increase performance. Both WIL and QVE from memory initially wanted to take the low turnover approach to get the LIC CGT Status. It was a bad mistake for WIL who reverted to their more active style and morphed into WAX. Obviously a great decision. QVE recently decided to become a trading LIC as the very low turnover strategy wasn’t working for them. Not that they’re a high turnover LIC but < 10% turnover didn't suit their Value Investing approach with modest turnover.

    It's very hard trying to manage risk with ones portfolio. I continue to adjust our investments over time in an attempt to future proof it. Not aggressively but enough to let us sleep well at night. Concentration and country risk is a major concern and one of the reasons for these adjustments.

    I suppose we are more fortunate than most in that if we really had to we could live well with a large part of our portfolio in cash / Gov't Bonds should the world get too scary. But for better or worse we continue to put our faith in productive enterprise. As to whether our money is invested in the right assets / locations only time will tell.

    Unfortunately there seems to be no perfect solution. No matter what any of us decide to do there are still so many unknowns. Hence why I suppose we continue to read, learn and discuss this stuff in an attempt to reduce the risk of seeing our life savings turn to crap.


    1. Thanks again for the link Austing. Have come across a few good reads on that site so will follow it more in the future. I thought I would add a link I came across today as it covers a few of the themes I touched on in this blog post. I made the comment such themes were not necessarily being widely discussed. I think that is already changing, and expect more articles like this below to appear in the future. The positive “wealth effect” from rising house properties that economists used to discuss 10 or 15 years ago may now be a negative.

  3. Yep, the article makes sense to me.

    Of course I make no secret of the fact that I hate property. Been there done that. I also personally don’t like having too much debt. At the moment we have NIL debt and a fat cash buffer. Doom and gloom, bring it on. It’s what I live for Investment wise. I’ve been through a few crashes / bear markets now and hope to enjoy a few more in this lifetime.

    Quite frankly all this damn intervention in an attempt to prevent boom and bust cycles I feel is counter productive. Call me cruel but when it comes to money I think it’s the nature of humans to repeat past mistakes. Hence let the cycle play out without intervention so the full effect of pleasure and pain is felt. At least it’s probably more likely to get it over and done with quicker than a long drawn out death by a thousand cuts!

    Again the article makes sense but how exactly it will play out nobody knows. I’m not very good at predicting outcomes but I’m always prepared with a plan of action to take full advantage of it when the sh*t hits the fan.

    I’m sure the majority will disagree with me. But that’s the beauty of opinions, we’re all entitled to have one.

    Thanks Steve for the opportunity to comment.


    “Beware of using interest-only loans

    And finally, back to Australia. A great many people here, particularly high-income earners, have become very frustrated by the superannuation curbs and have been taking out interest-only loans to buy residential property using negative gearing. Indeed, some 50 to 60 per cent of Australian bank investor loans are now interest-only.

    Combined with the Chinese buying, this has created a major buying force which has boosted dwelling prices in Sydney and Melbourne and also helped the other capital city markets.

    The government, bank regulators and the Reserve Bank are determined to stop this continuing. In their anxiousness to prevent a housing bubble that might affect the prosperity of our banks, the regulators and government are playing a dangerous game.

    What they probably don’t realise is that with non-public servant incomes depressed and low interest rates affecting self-funded retirees, rising power and gas prices are beginning to affect consumer spending. In the first few months of this year food expenditure is up (so the supermarkets will be happy), but café and restaurant expenses are down.

    To save money we are eating more at home, which surprises me. Meanwhile, we are cutting back on other areas of discretionary spending. What is really helping the total scene is the wealth effect of higher dwelling prices.

    If that is stopped we will see a much tougher retail sector. And we all know, as that starts to happen, it will affect income levels throughout the community.

    For what it is worth, I would be cautious of taking interest-only loans to negatively gear houses in this environment.”

    1. This article you posted Austing was the type I expected to read more and more when I initially made this blog post. This style of news flow seems to have come quicker than I imagined due to APRA acting on interest only loans after I posted. Then the RBA spoke and seems to be placing all the responsibility on the government and APRA. One thing I find puzzling though is stating that the wealth effect is still helping things, I am not sure how we can back that up for sure. Consumer confidence has been in a long structural decline in Australia from what I can see. If the wealth effect was helping I would have thought measures of confidence would be much higher.

      Here is another example of the reporting I thought we will see more of. Fund managers making the case for investors to own less of the major banks as their investment strategy. ETFs have grown in market share and I expect more Australian fund managers to highlight some potential weaknesses in diversification that some have.

      Here is a link with an example of that.

      Maybe the correcting mechanism for the Australian economy comes from the exchange rate which is now looking soft since I posted. Politicians still flirting with first home buyers maybe using their super I hear to keep the bid strong on their investment properties. RBA scared to prick the bubble by raising rates, by the same token probably scared to cut and also be criticised by so many for blowing the bubble further. The foreign exchange market is perhaps where things are the least likely to be manipulated and so far the AUD is reacting negatively, assisting those that have diversified offshore to some extent.

  5. Hi Steve,

    I agree that there were some contradictory comments in Gottleibson’s article but posted it here to show that part of what you said is gaining momentum rather quickly.

    The article on local banks makes sense and similar to what I’ve seen by other authors. I don’t tend to be much of a seller but I certainly haven’t been a buyer of anything much local for awhile now, particularly large cap focused. As a retiree in particular I will only buy when the risk is low and margin of safety high. Bloody ASX and it’s concentration in banks and miners. Hence why I’m atracted to EX-20 product by proven value investor IML.

    Re the exchange rate from an article in AFR today by Giselle Roux:

    “Is it possible to build a defensive equity portfolio while still maintaining a set weighting to the asset class? A partial solution is to mix up one’s equity exposure between local and unhedged global stocks. This can work because the Australian dollar usually comes under pressure when economic trends turn negative. The correlation over the past five years between the MSCI All Country index on a hedged basis and the S&P/ASX200 is 0.68, whereas the unhedged correlation is 0.41. This however, does take into account a period when the local dollar fell sharply.

    It also pays to look at the products in a global portfolio. Passively managed products, which follow an index such as the S&P500, the FTSE 100 and the Topix in Japan, by definition offer no protection against market downturns. This is not an anti-passive rave, rather, with index products, we know what we are going to get.”

    The biggie that I think many of us are waiting for is what’s around the corner for the overheated US market and the flow on effect to other global markets.

    And speaking of that I assume you’re aware that Star Capital have updated their data to 31/3/17:

    This in particular –

    No one knows what will happen but I’m very content to be sit patiently on the sidelines when it comes to investing anymore into markets at this time. The reality is we really don’t need to own more shares so I’ll only buy when exceptional opportunity arises. Those of us who rely totally on our investments to live on can’t afford to invest unwisely! In my case of not being very smart when in doubt it’s a case of watch and wait.


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