Good evening,

Fair to say it’s been one of those days, nothing’s gone right, I’ve had some IT dramas and it’s 5pm and I’m pretty much just getting down to ‘business’ now. ASX 200 index is down 43 points (0.65%) on Friday’s close and down about the same on this time last week, though a few dividends were paid so after dividend reinvestment the index was actually up 0.37%.

The market is looking expensive. You are really paying a higher price for a crappier earnings outlook. Yep, it’s a crappier earnings outlook at lower interest rates, but for mine, I’m not going to buy stocks with a low return just because the return on everything else is sub-3%.

We’ve all learnt by now (surely!) that you want to buy stocks when you think they’ll make more money, not less. In aggregate, you can’t make more money as a business if people aren’t spending more money (if this still doesn’t make sense to you, watch Ray Dalio’s economic cycle video again – link here).

Consumer sentiment by demographics below (courtesy of Citi Research) – it’s a pretty sad state of affairs.

Bond proxies and long duration assets (transport & infrastructure) are outperforming the rest of the market as a result. Just give me a yield, any yield will do!

I saw another weekly investment note (from a firm I’m relatively familiar with… not naming names) talking about the differentials between the PE on CBA vs ANZ and the relationship between household borrowing and business lending, which is usually inverted. Look, I agree that I’d rather own a business bank than a mortgage/residential bank right now and I think ANZ is probably the pick of the bunch…

However, the gap exists at least in part because CBA is cum-dividend in August while you’re not getting paid by ANZ until November.

Here’s the average CBA PE relative to ANZ by month for the last ten years. As you can see, the highest premiums historically exist in June/July and Dec/Jan, i.e. the month’s leading into the dividend. Rocket science this is not.

But my compatriot does have a point; average June/July PE “premium” is 17%; currently, 34%… For those who wanted to forgo the income, switching probably makes sense, but you’d have to be more broadly positive on banks. For mine, you’re not getting much more out of the banks in share price upside, so it’s a case of do they move together?

If you were thinking about it, you’d have to ask yourself is CBA or ANZ more sensitive to a negative market move? What’s the quantum? Interesting, hard to answer questions; ANZ has higher vol (21% vs 16%), higher beta and lower quality, so if markets fall I’d bet CBA outperforms ANZ.

For the average investor, it’s probably unnecessary stuff. More important is how much of your portfolio is exposed to banking and what you expect to get out of that investment over the next 3 or so years. I mentioned this to show you the cyclicality of the banks around dividends.

Speaking of volatility, I read a fantastic article from one of my favourite financial bloggers, Of Dollars and Data last week. It’s titled The Price of Admission and is worth 10 minutes out of your day.

For the lazy or particularly busy, here’s the short version. Pretend I could tell you correctly how much the market was going to go down during the calendar year. I knew exactly how bad it would become. What number would convince you not to invest in stocks and buy safe bonds instead on 1 Jan?

While the article talks about the US, I’ve replicated in Australia going back to 1992 for the ASX200 Accumulation Index.

Here’s some data, on average, the market declines by 8% each year meaning if you bought the ASX 200 on Jan 1, on average, you’d be down at 8% on your investment at some point during the year.

Like my mate Nick, I’ll assume we start with $100, are super conservative and can’t even tolerate a 5% fall in share prices. You magically avoid all the years with more than 5% negative returns.

You actually end up with less money than the investor who just participated each year. You average a return of 13% vs the index of 14.1%!

In fact, avoiding drawdowns of 10% or more only gained us 0.4% additional return or a total of $10 more money over 28 years.

Only avoiding 15% drawdowns made a more material difference, adding $32 more dollars to our asset pool and increasing returns to 15.2% from 14.1% on average. Our data set isn’t as good as the S&P500, so I won’t continue, but you get the idea.

The lesson here, like in the original article, is that avoiding above average drawdown matters, while accepting smaller drawdown is part and parcel of the game and, in fact, a crucial part of generating higher returns.

The blog encourages us to accept drawdowns of 5-15% as “the price of admission” – you have to be willing to earn your upside with some volatility. Below chart shows the tipping point of about 15-20% max drawdown in any year for the S&P 500.

Finally, it’s important to remember, in the last 28 years, we’ve experienced drawdowns of greater than 15% in only three years. Even in the moderately volatile years when we’ve had 5-15% drawdown, the ASX200 still averaged returns of 6.3% for the calendar year.

Like Charlie Munger says:

Movers & Shakers

Breville’s (BRG) a good business, nice to see the market remember that. A couple of market darlings I don’t rate so highly, WiseTech (WTC) and A2 Milk (A2M) also had solid weeks. Retailers got a kick as a few of the value investors sniff an election consumer bounce (JBH, PMV, SUL, MTS)… I think not.

Afterpay back in the doghouse, AMP a basket case and stopped paying it’s dividend and will more than likely need to raise equity…ouch. ALQ dipped after a nice bounce recently whilst a few other industrial/cyclical names suffered as growth expectations waned.

Have a good week,
LL