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Profiting from a holding pattern

Just over a year ago, on 16 June 2016, this appeared:

  • The global investment outlook remains difficult. The numbers are mildly positive, but there are significant risks.
  • The global outlook is further clouded by the conflicting actions of central banks. While the US Fed tightens, banks such as the European Central Bank (ECB) and the Bank of Japan (BoJ) continue to man the pumps. These cross flows add to market volatility and uncertainty.
  • The outlook for the Australian economy remains modestly positive, despite a number of local distractions such as the Federal election campaign. Sentiment swings are the likely major driver of market moves in this scenario.
  • The share market performance overall could remain sideways, with the Australia 200 index respecting a range between 4800 and 5400.
  • This means “buy and hold” strategies are unlikely to deliver the best returns. Instead, rewards in the current environment may go to active investors – those willing to take advantage of market swings.

Today, I would update the first two points, and change the range for the Australia 200 index to 5,400 to 6,000. And that’s the problem in writing investment strategy. Sometimes conditions evolve over time, meaning that the “right” strategy remains the same. The chart above shows how the index traded over the past year.

The modest upward bias saw a 9% capital gain for an index portfolio, plus any dividends (around 5% with franking). A 14% return when cash rates are at 1 5% is respectable.  However many investors will report returns lower than the bench mark. Overweight cash positions are one contributor to weaker returns. However there are a couple of strategy points that could have improved performance for many investors:

Sentiment swings are the likely major driver of market moves in this scenario.

Rewards in the current environment may go to active investors – those willing to take advantage of market swings.

As the chart shows, the main index has traded sideways for most of 2017. With a couple of breaks, it has largely respected a very narrow range between 5670 and 5825.

Naturally these market conditions will not last forever. At some stage there will be a move away from the current range. The likely trigger is a change in the macro economics. A burst of inflation or wages growth could see shares break upward. A dramatic sell off in bonds is another potential positive driver. On the down side possible market disruptors include disappointing growth numbers in China or the US, or political dysfunction in Europe or the US.

Barring a macro event the range trading is likely to persist. This demands a strategic response from investors who have not already adapted.

The recent experience in retail stocks illustrates a source of potential opportunity. The whole sector was marked down on the “Amazon effect”. This was NOT due to any change in current earnings or any evidence at the company level of any negative impact. In other words the sector was marked down on sentiment alone.

Aware investors may have snapped up JB Hi-Fi at levels close to the $21.20 low just six weeks ago. It’s now trading close to $25.00. Similarly Harvey Norman traded down to $3.59, and is now closer to $4.00. Gains of 10-20% in just two months can significantly improve overall returns.

The good news is that the market may see more sentiment induced swings as Australian companies head into the full financial year reporting season. The news flow begins in the first week of August. Now is the time to identify good investment AND profit taking opportunities and create a watch-list. Any sentiment induced swings in the lead up to a company’s earnings announcement could be an opportunity, albeit at higher risk ahead of the event.

Two sectors are high on my list due to recent moves. The real estate investment trust index is down around 12% in a month. This is an unusually large fall for a sector considered capital stable. Despite concerns about higher interest rates hurting valuations bond markets have rallied back strongly over the last week. And the REIT sector is yet to react.

The other sector on the radar is Healthcare. The fall in the sector index in the last month is around 8%. While not as dramatic as property, this swing largely on fears of change in the US healthcare landscape could be a chance to buy into a sector that in recent history has traded at lofty multiples.

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