Easy tiger: Why you should scale down your sharemarket exposure

Most Starts at 60 readers will remember Mortein’s Louie-the-fly television commercial from the 1960s-1980s, whose tagline was, “When you’re on a good thing, stick to it.” And while that might apply to fly spray, investors blindly adopting the same philosophy when investing, risk suffering the same fate as Louie.

Now might be a very good time to settle down with a cup of hot chocolate and take stock of where you are, because it might be time to reduce your exposure to shares, rather than piling even more money into the market.

Over the past couple of weeks of August 2021, the Australian sharemarket has regularly set record, all-time highs. And for most retirees, or anyone using superannuation, the performance of the sharemarket has a major bearing on the returns enjoyed by their super or pension funds. A high-growth fund probably has about 90 per cent of the money exposed to shares, a balanced fund about 60 per cent, and a conservative or stable fund somewhere between 30 and 40 per cent exposed.

The ASX 200 measures the largest 200 shares in the Australian share market by value. In March 2020, the ASX 200 hit an 11-year low point when it collapsed to about 4,400. Over the past couple of weeks of August 2021, it passed the 7,500 mark, representing a staggering 70 per cent improvement from the early 2020 levels. That meteoric improvement has underpinned many of the outstanding performance reports dished out by super funds.

But don’t get sucked in! The market crashed last year, thanks to the uncertainty surrounding the immediate effects of the evolving Covid-19 pandemic. Following that crash, classic John Maynard Keynes economic strategies kicked in. (Keynes was the economist whose theories and strategies dragged the world out of the Depression in the 1930s, and “Keynesian” economics still drives most economic policy decisions today.)

Billions have been injected into economies around the world to keep economies ticking over and to stimulate growth. Further to that, ridiculously low interest rates have kicked in, resulting in a surge in asset prices as investors took advantage of what amounts to almost free money. It’s also been helped by the fact depositors are being paid less than 1 per cent per annum and are desperately chasing income. In Australia, cheap borrowings and other incentives have been big contributors to the surge in house prices and other asset prices, such as shares. But, like any good party, the booze in the form of free or cheap money will one day run out and — when that happens — the party will end.

There are a number of measures used by market experts to determine what represents fair value for an asset. Real estate investors, for example, might look at the rental returns verses the price of the property. One simple measure that share investors often use is a ratio that measures the current price of a share relative to the earnings of the share. We call it the Price Earnings (PE) ratio. While there is a degree of subjective opinion here, some professionals will say that, typically, a share with a PE between 10 and 15 represents a “fair value” range. Some will say that range could stretch up to 20.

In the depths of the Global Financial Crisis, the ASX 200 PE ratio sank to about eight. It was a good time to buy quality shares. Just prior to Covid-19, the PE ratio of the ASX 200 was about 20 and, even then, some were warning that the market was beginning to look a little overcooked. Take a sip of your hot chocolate because, right now (mid-August 2021), the PE ratio of the ASX 200 is above 22, having peaked a few weeks ago.

However, that’s not a reason to do a wholesale bale-out because there are distortions. Abnormally low profits for some companies triggered by lockdowns are also offset by abnormally high profits for others (boosted by the government’s JobKeeper payment).

In the main, the high PE ratio is caused by investors’ confidence that the effects of Covid-19 on company earnings will ultimately wash-through. But never forget, there are two variables that determine a PE ratio: the earnings, which will hopefully be restored, or the price. Normality will eventually be restored. Either the earnings will increase to justify the price of shares, or the prices will come down.

Beware the investment “gurus” who declare these times reflect a new world order or a paradigm shift. The old rules will still apply.

So, if you’re a retiree and looking at healthy gains made by your pension fund over the past few months, don’t be afraid to take those profits off the table and park the money into the cash option of your fund. That’s where the regular monthly pension payments should be coming from – the portion held in cash.

If the market continues to roar ahead, you’ll still have an exposure to the gains. But if there is a correction, you can sit tight because your pension payments for the next year or so should be covered by the cash profits you collected, having been added to the cash you already have.

Louie-the-fly can stick with what he likes. I’ll bank my profits when the time’s right, thanks very much!

IMPORTANT LEGAL INFO This article is of a general nature and FYI only, because it doesn’t take into account your financial or legal situation, objectives or needs. That means it’s not financial product or legal advice and shouldn’t be relied upon as if it is. Before making a financial or legal decision, you should work out if the info is appropriate for your situation and get independent, licensed financial services or legal advice.