By Michael McCarthy, Chief Market Strategist, CMC Markets Australia
“Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” – Sir John Templeton
Market action this week suggests the worst of the storm has passed. It’s not just 100+ point “melt-ups” in the Australia 200 index either. Whether it’s the German DAX
Index, the price of oil or USD/JPY, markets are reversing previous losses as risk appetites around the globe rise. Significant gains are already in place for some shares, and investors who don’t want to miss out entirely feel they need to act.
Remember the pessimism that marked the start of 2016? Rolling bearishness, with commentators and investors jumping from one trigger to another to justify relentless selling. The reasoning became tenuous. The People’s Bank of China is stimulating the economy – things must be worse than we thought. Sell. Strength in the US economy means interest rates will rise, dragging on valuations. Sell. Oil prices are much lower, which could spark a banking crisis if drilling companies can’t pay their debts. Sell.
This sort of reasoning tells us more about market sentiment than it does about economic fundamentals. No matter the actual event, the market interpretation was bearish. Note that each of the three factors mentioned above – PboC stimulus, a stronger US economy, lower oil prices – are also potential positives for shares. The fact they were treated as negatives tells us the dial was much closer to pessimism than optimism.
The stronger share prices are not moving on shifting fundamentals, even though some stronger than forecast data is clearly helping the situation. Improvements in US durable goods orders, and consumer income and spending are welcome and supportive of higher share prices, but manufacturing data in China is arguably worse than before the sell-off. Although Australian growth for the last quarter of 2015 came in at 3%, well above expectations closer to 2.5%, GDP is generally disregarded by markets as backward looking.
Overall, the numbers are consistent with a modestly positive outlook for the global and Australian economies.
However, the subtlety of the situation is in itself a problem. It is difficult (close to impossible) to make a comprehensive bull or bear case at the moment – the evidence remains inconclusive at either extreme. The problem is that sentiment then becomes the dominant mover of markets, and a short string of economic numbers pointing in one direction can have market commentators jumping at shadows in a desperate race to be the first to call the end of the economic world.
This is not only unseemly, it can be severely damaging to investors’ wealth. Selling with a panicking crowd, then waiting for confirmation of a turnaround before buying back in can lead to whip-sawing, especially if the market fluctuates repeatedly.
Given expectations of increasing volatility and broadly sideways trading as sentiment whips markets around a central modestly positive outlook, how can investors respond?
Get a bit contrary
When media outlets and weekend barbecues are dominated by bad economic news and dire market predictions it’s difficult to step up to the plate. No-one wants to look or feel foolish by buying and being wrong. Nonetheless, we’ve just seen that it was the best time to buy. Similarly, when your Uber driver is talking up the market and giving you share tips, it may be time to sell. Going against the crowd takes courage, but could be the most rewarding strategy in 2016.
Individual stock performances could be key to good returns this year. While the market is about 5% off its lows, stocks like Oilsearch are already up 24% from its low. A mixed portfolio of quality stocks will likely see a number of star performers.
Know your price
Determine the stocks you want to own for the long term, and the price at which you are happy to buy them. This price could be determined through a detailed evaluation of the company, or it may be as simple as knowing at what share price the dividend yield becomes compelling to you. Looking at the shares in your portfolio, at what price would you say they were grossly overvalued? Whichever side of the coin, know the price, and be prepared to act if the share price gets there.
There are no guarantees in life, or in markets. Share prices may resume their fall. However, unfolding in the market right now is a credible turnaround scenario, and may be the beginning of a move to test 5,400, or 8% higher from here. Those who refused to “catch the falling knife” may now find themselves “chasing a runaway train”.