Thursday, March 22, 2007


Blue Chip Blues

Most long term investors favour Blue Chip shares. "Blue chip" companies are large, well established companies that are considered to be strong and dependable, including such household names as Telstra, BHP, Woolworths and the ANZ, Commonwealth, National and Westpac Banks.

Such companies are generally perceived as reliable investments. But unfortunately, it ain't necessarily so...

Consider again, Telstra. Here's a chart of the price of ordinary Telstra shares (the red line) over the past five years - 2002 to 2006 inclusive:

Telstra 2002-2006
Telstra opened on the first trading day of 2002 at $5.43, and closed on the last trading day of 2006 at $4.14. Annualised, that's equivalent to a loss of 5.28% every year for the past five years!

Amazingly, this performance occurred during the longest running bull market in the history of the sharemarket according to the following story published in the Daily Telegraph last July. (The green line in the chart above shows the spectacular rise in the All Ordinaries Index over the same five year period.)

Bullish run 'set to end'

Published in Daily Telegraph July 2006

WE are now in uncharted territory, according to Wealth Within chief analyst Dale Gillham.

Never before in the history of the Australian share markets, he said, has there been a bull run for as long as the one which we are experiencing now.

Mr Gillham said the run is now in its 40th month. Previously the longest run was 39 months and that ended rather spectacularly in late October, 1987.

Back then the market fell by about 25 per cent in one day and about 40 per cent over a month. Much money was lost.

Mr Gillham doesn't believe the same fate awaits the market today. And he is not saying the market will fall into a bear mentality leading to a recession. Rather he said the days of high double digit returns and the safe environment for speculative moves are over. Although, as he concedes, we have never been at this point before therefore the bull run could still continue.

"But I believe the market is just about dead now," he said. "I'd been expecting it to come in June. It hit 5352 on May 10 and I think that is as high as it will go. "July will still be bullish, but I don't believe it will continue much longer.

[Seven months later the index reached 6000 points! - John :-) ]

"Statistically the end of the bull run is indicated by rising commodity prices, rising inflation, low unemployment, lots of speculation and volatility."

All these factors are present, with volatility - where the market is rising and falling by a full 1 per cent or more in a day - especially giving the share market an anxious edge.

Mr Gillham stressed that the market is in a much better position than it was in 1987 and there won't be blood on the floor.

A bull market is defined as prolonged period during which market prices rise faster than their historical average. It can happen because of an economic recovery, an economic boom, or investor psychology. Some believe when the market falls by more than 10 per cent the bull run is over. Others say the fall should be 20 per cent.

A bear market is defined as a prolonged period during which prices fall in a mood of pessimism. It usually happens when the economy is in a recession and unemployment is high, or when inflation is rising quickly.

A correction happens when the period of falling prices is short and immediately follows a period of rising prices, such as what happened to our share market in May this year.

"Human emotions run the market," Mr Gillham said. "If we are feeling optimistic we overbuy, if we're not feeling optimistic we oversell."

He says because of the rising oil prices and interest rates, people have less to spend in the shops, which in turn will affect retailers and manufacturers.

"And if people are worried about their jobs, they stop spending," he said, adding the new industrial environment with the threat of pay cuts and job losses will contribute to a more cautious approach to money.

"When the bull run ends, a lot of people will lose their money if they don't acknowledge the new environment, but smart people won't."

"People never buy shares for them to go down so they should be aware of what's happening in the market."

And more and more Australians are investing in shares than ever before. In 1991 less than two million had a money invested in the market; now it is about eight million. For these people, Mr Gillham was of the opinion the market will stay flat for 18 months to three years.

He also said managed super funds will struggle for the double digit returns they had for the past two to five years.

"All ships rise and fall on the same time. Smaller funds will do well and self-managed funds will too, but only if they know what they are doing."

But you can still make money when the bull run ends, Mr Gillham argued. "The market is driven by the top 20 stocks. Small stocks can pull away but not affect overall market movements," he said. "It's a case of knowing what you are doing and knowing where to look."

Bridges head of equities Peter Hilton was less pessimistic about the future. "I don't think the bull market is over but we will revert to lower returns," he said. "(But) we certainly will not have the high returns (from shares) of the past three years."

Mr Hilton expected the market to move sideways where it will still be comfortable but will not offer the same spectacular double-digit returns of the past couple of years.

He suggested investors retain a long-term purpose. "If they've been speculating, then they've done well in the past few years," he said, "but now is the time to rein in this activity and return to the fundamentals. And have some cash up your sleeves."

CommSec's Charles Hyde reckoned there is still room for growth in the market.

"I believe the year will end higher than it is now," he reasoned. "The market is not yet stretched.

"There will not be the same sort of gains as in the past years, but I don't see any reason why the market can't deliver good returns."

So whatever way the market goes, it pays to take heed of the two rules for investment from the small investors' guru Warren Buffet.

The first one is don't lose money. The second is don't forget the first rule.

By Jenny Dillon

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