The Australian share market is off to a great start to 2017. Anticipation of Trump inspired stimulus in the US is driving commodity and share prices higher. Despite an easing of bond yields, and some support for gold, it is apparent risk appetites around the world are higher.
The high water mark for the Australia 200 index in 2016 was 5,699. On the first day of trading in 2017 the market sliced through this point and has not looked back. The index has a perfect record, with gains on all five of the trading days so far this year.
While this is encouraging, investors will no doubt recall the damaging sell off that began in early January 2016. From a purely behavioural point of view this makes a sell off this year less likely, as the fresh memory of the painful market moves means many investors are positioned much more defensively.
Another factor to consider is that five days is a very short time in markets, and the moves may eventually prove themselves just noise. Investors contemplating the outlook for the year may start with the big picture. The weekly chart for the last ten years is a good starting point (above).
On the left is the GFC sell down that extended from 6852 in November 2007 to 3120 in March 2009. These are the lines in the sand – any trading above or below these points would be highly significant. Although there are large swings along the path, the overall bias in the market since 2011 is upward, and that bias is evident since the February 2016 low. The up-trend is now through resistance at 5600 and on balance many will consider a test of 6000 likely in the short to medium term.
Despite this positive bias, high levels of risk remain. None of these major threats may come to pass, but still demand consideration. US political risks, weak Japanese and European growth, potential credit crises in China or Europe and possible inflation outbreaks are in the mix. None are new, and none have occurred yet. However, the experience of the past five years is that markets may inflict large amounts of self-inflicted damage in anticipation of one of these, or other, risk events.
This combination of factors mean investors seeking superior returns cannot afford to miss the up-trend, but must prepare for regular sentiment induced swings in market prices. The red line at the bottom of the chart is the realised volatility of the market. After the spike in Q1 2016 it has settled back, but remains above the lower levels of 2013/14. In my view, this is the low point for volatility for the year, and market moves will pick up in size and speed.
What’s an investor to do? The response will depend on individual circumstances. There are a number of potential strategic responses but it is clear they must prepare for a year like 2016 again. Buy and hold is in my view an unlikely winner in 2017. Instead the rewards are likely to go to active investors – those who are prepared to take advantage of the anticipated market swings.
Active approaches may include selling out good gainers to buy back in at lower levels. This may apply to a single shareholding, a proportion of a portfolio, or the whole portfolio. Alternatives include taking asymmetric risks with options – holding cash and buying call options or holding a portfolio and buying put options. Further, investors may hold their portfolio throughout the swings, while managing their exposures with CFD position over the index and/or individual stocks.
Alert readers have seen this before. That’s no accident. Investment plans, and investment strategy, are longer term approaches, and change only with important changes in market conditions. My opinion is that 2017 will be like 2016, only more so. That is, there will be a central, modest improvement in overall market levels, but the path to those high points will be even more volatile than last year.