If you’ve just returned from holidays – welcome back. I hope you’re tanned and relaxed, because there’s something you need to know. While you were away, markets have been very busy. First, you may want to check the value of your portfolio.

20160120 xjo

The chart shows the Australia 200 index fell from a year end close above 5,300 to below 4,800. This 10% decline occurred in just 2 weeks, giving Australian investors their worst start to a year ever.

What happened?

Evidently, there were more sellers than buyer. But why? This is the real problem. A number of suspects are identified:

 

 

 

 

 

  • China fears. The relentless prediction of a “hard landing” rolls on, now in its fourth year. Despite 100% inaccuracy, this market bogey man continues to periodically emerge to spook markets. This time, the catalyst was a weaker Yuan. Some interpreted the weakening of the Yuan as evidence of huge investment flows out of China (huh?) AND that the People’s Bank  of China was failing in its efforts to stimulate the economy. Thankfully, the release of GDP, industrial production and retail sales numbers this week unequivocally show a steady state in China in Q4 2015. If this is a rational fear, it was comprehensively answered. While there was little to support this idea in the first two weeks of 2016, it’s an appealing explanation as it does explain why Australian shares were hit harder than most. Global investors selling China-exposed Australian shares because of trading restrictions in China is one of the more credible theories to explain the sell-off.

 

 

 

 

 

 

  • Higher US interest rates present a significant challenge to asset prices. While this is undoubtedly true, it is hardly news. In fact, as the rate rise came in mid-December, proponents of this theory need to explain why share markets rose in the two weeks following the Fed decision, before selling off.

 

Neither of these explanations bears close examination. They are not new, and there was no new data or other evidence to lend significant support to them in the first two weeks of the year. Instead, in my opinion it’s more likely the buying in the last two weeks of 2015 is the culprit.

December 31 is month, quarter and year end for many professional managers of share portfolios. There is a common desire in down years to present a better performance. Additionally, as many portfolios will be reported, underweight and overweight positions are often reduced in “window dressing” exercises.

This can mean some fund managers start the new year with an overbought position – they are holding excess inventory. In my view, the selling of this inventory was the spark that lit a bear fire under the markets. In other words, this turned into an old-fashioned market panic.

The good news for rational investors that can hold their nerve is that shares are now at more attractive price levels. The economic outlook remains modestly positive, with some (often over-stated) risks. This should mean a broadly sideways trading year, as market sentiment swings from cautious optimism to gloom and fear, and back again.

In this environment, the rewards go to active investors – those willing to buy at lower prices and sell at higher prices. Looking again at the chart, a simple approach is suggested. Buying shares when the market is closer to 4,800, and selling when it’s closer to 5,400, could boost returns significantly, especially if the market cycle repeats itself a number of times over 2016.