Disaster in the headlines, huge moves in markets, worries coming from all directions- property prices, commodity markets, China, US rates, Brexit. Despite the overwhelming flow of bad news, share markets make gains, and in some cases hit new highs. Welcome to the new, normal investing environment.
I’ve written before about the changed investment world, and methods and strategies investors can employ to suit the market conditions (Investment Strategy and the Reporting Season, Australian Shares Back in the Zone among others). Individual approaches will vary, but the central thesis is that share markets are likely to swing wildly around a central, modestly positive economic outlook. The swings will reflect sentiment changes, as the conflicting currents set up by differing central banks around the world will obscure the true picture, and markets will seize on limited evidence to push share prices too high and too low over the course of the year.
There are many possible strategic and tactical responses to these choppy and volatile conditions. Investors who are more active will be the likely winners over 2016, as they take advantage of repeated sentiment induced swings.
Not all investors can buy when the headlines are screaming meltdown, nor sell when the headlines are singing market strength. However, an active approach can also incorporate more concentrated stock picking. That is, identifying stocks that represent good value, and going “overweight” these stocks with a view they may outstrip their peers as their share prices play “catch up”. Other investors will prefer a momentum approach, sticking with the stocks that are largely moving in the right direction, and cutting those that disappoint.
The active approach can be applied at the stock and at the portfolio level. Where a stock hits the buy or sell zone, it’s easy to act. But it’s also important to act on overall asset allocation when the broader market is hitting its edges.
The Australia 200 index is close to the middle of its recent trading range. For some, this makes the asset allocation decision (share, property, bonds, cash) neutral. There is no reason not to act on favoured shares that hit either low or high prices. It may also be an appropriate level for switching between individual stocks and/or sectors.
The call to action becomes compelling at the extremes – the zones defined by the gold lines (4,775 – 4,900) and the green lines (5,290 – 5,350).
However, one of the challenges for investors is that the size of the move into the zone, and the length of time that it trades there, are not knowable beforehand. The most recent pullback was shallow, barely brushing the top of the gold zone. On the other hand, the previous pullback appeared to threaten a major sell-off, and pierced the lower gold support line before rallying back. Similar behaviour is observed on the upper bounds. At times rallies barley make the lower line, other rallies push through the upper band, or hang higher for a number of sessions, before falling back.
What is a reasonable strategic response to this kind of market action? Investors can prepare beforehand for these peaks and troughs, identifying the stocks to be bought or sold when the index moves into the buy or sell zones.
As the market approaches the zone, investors act. If the current rally continues (likely in my view) investors may place orders to sell 10-20% of their intended amount when the index nears 5,290, placing further orders over the following sessions. The idea is to ensure action, not waiting for “certainty” and giving up the opportunity.
A similar approach could suit buyers if and when the market pulls back toward 4,900 again, starting to accumulate preferred stocks as the index falls through 5,000, and adding to the positions in any further falls or over time.