Kuta Beach

Kuta Beach

Friday, 25 January 2008

The January 22 Global Crash

On January 22, the Australian stock market went down 7 per cent. Since the last major crash that happened (a 10 per cent decline in one day) happened in 1989 when I six years old, this is the first crash I have ever been aware of and the first that has affected me. Australia was not alone. Just about every stock market in the world saw huge falls.

At the end of December 2007, my net worth was $28,120, which is pretty low compared to some people. The average Australian has a net worth of $400,000, but then again the average Australia is much older than I am.

Even though the Australian stock market as measured by the ASX200 fell to 5200 on January 22, today as of lunch time, three days afterwards, it has gone back up to 5700 and it seems to be climbing to 5800. I have heard some people saying this is a great opportunity to buy because the price-to-earnings ratio has dropped to 12 now from of 15. Yesterday I received $560 from my part-time job and immediately put it in my mutual fund. I have, however, heard some people say that we haven't seen the worst yet. Financial heavyweight George Soros says this turmoil is the worst since World War 2. It's difficult to know what will happen for sure, but my portfolio is diversified, although slightly overweight in Australian shares.

Practically all of my money is in the stock market. I keep between $100 to $500 of emergency money in my bank account just in case, but the rest I put into equities. I also have a $5000 car, which counts as part of my net worth. Even though I have a Commsec account, I have forgotten both my password and my user number, and I have been too lazy to talk to the bank to reactivate it. I only ever bought ETFs on the ASX, mainly StreetTracks ETFs simply because back when I remembered my account password they were the only ETF providers in Australia. Nowadays, iShares offers ETFs and their major selling point is that they provide exposure to Asian markets. Given the exploding rate of growth in Asia and other developing economies like Latin America, Russia, etcetera, I believe I should be more exposed to emerging markets. What I have noticed, however, is that the Australian stock market seems highly correlated to the performance of emerging markets. Many commentators say that Australia's economic boom is riding on the back of China's economic boom. To give evidence for this, look at the strong correlations between prices for iShares Australian ETF and iShares Emerging Markets ETF. Given that Australia's major business is mining and resources, then it makes sense that Australia will grow proportionately with emerging markets since developing countries need resources to develop economically. So then, it may just be enough to invest in Australian shares to receive exposure to emerging markets.

I am interested in risky stocks because I am still young and can ride through volatility. I also see risky stocks as an alternative to margin lending. You can gear with stocks through margin lending, that is, borrowing to invest. If I were to get a margin loan I would have to be careful because gearing amplifies both your gains and losses, meaning you can make more but you can lose more as well. The risks apply both for residential property and gearing to invest in mutual funds. To save the hassle of margin calls, I believe the best way to expose yourself to more risk with the possibility of getting higher returns (which effectively is what gearing does) is to bias your portfolio towards riskier asset classes like emerging markets or frontier markets, or even internally geared funds. A non-leveraged investment in risky assets is more or less equivalent to leveraged investment in safe assets. If you are going to leverage, you will need to invest in safe assets anyway because you need to be sure the return on your investment will completely cover the interest repayments you pay back to the lender.

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