Easier said than done right? If your Christmas/New Years break was anything like mine, I over indulged in food and drink, spent a lot of time catching up on chores around the house, and spent plenty of time at the beach and visiting friends and family.
The week and a half between Christmas and New Years is not only an exceptionally quiet time for the stock market, it is a time for reflection on the year that has just passed. It is a time to consider if you have been doing things right, and if you didn’t achieve your goals from the previous year, setting new goals for the year ahead.
2014 didn’t provide stock market returns that would have you quitting your job and sailing into the sunset on your luxury yacht. The ASX200 index gained a meagre 0.97% in 2014. That means, if you have invested $10,000 on the leading index, you would have made $97. And that doesn’t include brokerage costs.
With Australia’s Inflation rate currently at 2.3%, this means the real rate of return for the stock market has actually declined 1.33%. In this scenario, your $10,000 would have lost $133 (again not including brokerage).
The strategy that outperformed in 2014
For those who are regular readers, I have discussed the Covered Call strategy, otherwise referred to as the Buy Write strategy, many times. This strategy reduces risk of stock ownership, however, does limit the upside potential. While that might not sound exceptionally attractive, a quick revision of how the Buy Write index on the Australian Stock Market for 2014 might convince you otherwise.
The S&P/ASX200 Buy Write index (code: XBW) gained 9.2% in 2014. Now, considering the ASX200 didn’t even make 1% for the year, this is an exceptional out performance. In fact, it is greater than the long-term average for the ASX200 index. As denoted by a report produced by the ASX and Russell Investments in the “Long-Term Investing Report – June 2012” [i] , Australian shares returned 6.1% p.a. over 10 years, and 8.7% p.a. over 20 years.
XBW won’t always outperform the broader stock market however. The strengths of this strategy are when the markets are trending sideways, rangebound with very little up or down direction. A strong rise in the stock market will outperform the strategy, while a falling stock market could potentially see a decline in XBW, but this should be less than the broader stock market as the strategy reduces Risk in stock ownership.
Which market for 2015?
As the ASX underperformed in 2014, compared to global peers and against historical results, analysis for the reasons why can provide some insight into the outlook in 2015. One of the core reasons is the declining Iron Ore Price.
Australia is heavily dependent on the exports of Iron Ore, as well as other minerals. Commodities in general experienced a slump throughout 2014. The following chart from Forexfactory.com reflects the decline, which resulted in the lowest results since 2009 (following the Global Financial Crisis).
With this in mind, the outlook for Australia in 2015 is not looking very strong. The International Monetary Fund (IMF) World Economic Outlook (WEO) report that was released in October 2014, states they have lowered their global growth projections for 2015, down to 3.8%. Although stating “Steady Growth Ahead” for the Asia Pacific region, Australia has some hefty headwinds to battle to find renewed optimism amongst investors.
An alternative for your hard earned dollars in 2015 could be just across the Pacific in the US stock market.
Comparing apples with apples, the leading S&P500 index gained 11.8% in 2014. The 10-year annual average for this index is 7.67%, while the 20 year average is 9.85%. Hence, 2014 was a stellar year for performance. Inflation barely impacts the returns either, with the latest figures at 1.3%.
Such a strong performance is hard to beat for the Buy Write strategy. As represented by the PowerShares S&P500 Buy Write Portfolio ETF (code: PBP), it underperformed the broader market with a 6.4% return (including dividends), just a little more than half the broader market return.
Summary – what to do
The modern stock market doesn’t reward the traditional Buy and Hold approach. Especially during times of weaker economic activity. This is one of the key reasons why we focus so much on the Buy Write/Covered Call strategy. At the same time, International markets are expected to outperform Australia due to the impact of the Commodity Recession.
If you want to keep your investment portfolio in Australian stocks, a weaker outlook for 2015 suggests looking towards a Risk reduction strategy such as the Covered Call/Buy Write. Whether that is investing directly on positions in ASX shares, or looking for exposure in a fund/index that represents the strategy.
Alternatively, growth in the US has greater potential than Australia – as denoted by the World Economic Report released by the IMF. If considering this, make sure you discuss a Currency Hedge position with your advisor, as you don’t want to lose any gains in transferring funds back and forth. And if you are intrigued by the Buy Write strategy, you can invest directly into an Exchange Traded Fund on the US markets.
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