So, turns out it was a joke.
We’ve listened in on Reserve Bank of Australia governor, Glenn Stevens’ address to the Economic Society of Australia, and it’s a hoot.
OK. No it isn’t.
Opening his presentation, the governor said the RBA board had ‘deliberated for a very long time’ before deciding to leave interest rates unchanged.
The financial markets took him at his word and assumed the RBA was within an inch of cutting rates. That sent the Australian dollar into a tailspin from which it hasn’t yet recovered.
But whether it was a joke or no, either way it wasn’t funny. And besides, every man and his dog knows rates will fall this year. So if you haven’t structured your portfolio to benefit from that you better get cracking…
It’s important to remember that two things move markets – earnings and interest rates.
How so?
Simple. If a company can increase its earnings it becomes more valuable to investors. That means the share price should rise as long as investors believe earnings will keep rising.
And if the market expects the company to pass the higher earnings through to investors as a dividend, or that the company plans to expand the business through reinvestment, it will encourage investors to hold or buy the stock.
As for interest rates, that works for stocks in two ways. First, if interest rates are low it means lower financing costs for companies that are in debt. Second, it means bank savings rates will be low. And that means investors will look for alternative investments that pay a higher income – namely, dividend-paying stocks.
But low interest rates help another bunch of stocks too – growth stocks…
The Starting Point of Every Investment
Now, at first thought you might wonder how earnings and interest rates can impact growth stocks, especially small-cap stocks. After all, most small-caps don’t make a profit, and they’re so risky banks won’t lend them money. That means they can only get access to capital by convincing investors to buy new shares from the company.
However, earnings and interest rates still play into an investor’s thinking. For a start, even when you buy the most speculative stock on the market, you’re still thinking about the profits it could make in the future and therefore how high the shares could climb.
And even if you plan on selling before it makes a profit, the investor who buys the stock from you is also thinking about the future profit potential.
OK, but what about interest rates? Interest rates serve as the basis from which you judge the relative risk and reward of all other investments.
Put another way, if a bank account pays you a risk-free return of 5%, it doesn’t make sense to put money into an investment where you could lose half your money at worse, but only make 4% at best.
So that’s why earnings and interest rates have such a big impact on stock prices…even on some of the smallest stocks. Anyway, back to those growth stocks we’re eyeing up…
A chart that’s almost too scary to look at is the S&P/ASX Emerging Companies index. When you look at the chart below you’ll see why:
Source: CMC Markets Stockbroking
The index has halved since 2011.
Over the same period the S&P/ASX 200 is just about breakeven…better than breakeven if you include dividends. And if we go from the start of 2012, the Emerging Companies index is down 34%, while the blue-chip index is up 17% (plus dividends).
In other words, whichever way you slice and dice this market, it has been an ordinary…scratch that…it has been a terrible year or two for growth stocks.
That’s exactly why we like them so much.
A Bet Worth Making
We’ll be honest. We won’t say we’ve picked the bottom of the market here. We thought the bottom was in for small-cap resource stocks about two months ago. We even went on record to say stocks looked the best value since 2008/2009.
Well, if they looked good value two months ago, they look even better today.
This is part of the key to being a successful contrarian investor – buying stocks that everyone else hates. The biggest trick is the timing. Ideally you should wait until the stock or index hits rock bottom and then buy as it swings higher.
Trouble is, stocks rarely rise and fall in neat, straight lines. They tend to trick you into buying (and selling) just when you shouldn’t.
And sometimes – as happened recently – just when we thought things couldn’t get any worse. Only they did. The gold price slumped and dragged the gold miners and explorers down with it.
It wasn’t just the gold stocks. When the market goes through a rough patch as bad as this, investors tend to throw everything out of the basket, good and bad. That explains why there’s so much value in speculative stocks right now.
But to most investors speculative stocks look too risky. And so the mistake many will make is to think that dividend stocks are the only way to make money this year. But as we’ve shown above, low interest rates have a big impact on growth stocks too.
So knowing that rates are staying low (the Bank of England and European Central Bank both vowed overnight to keep rates low and stocks surged), the next step is to pick the right type of stock that stands to make the best gains over the coming months.
Dividend stocks still make sense. But don’t overlook growth. Our bet is it won’t be long before investors tire of income stock returns and look for tastier returns among growth stocks.
We thought that time had come two months ago…but we were too early. Today growth stocks look even better value than they did then. Is now the time to start buying some of the market’s riskiest stocks?
That’s our bet. It’s a risk worth taking. But we’ll only know for sure two months from now. Stay tuned.
Cheers,
Kris+
From the Port Phillip Publishing Library
Special Report: Just What are ‘Turbo Cap’ Stocks?
Daily Reckoning: How the Power of Tweets Saved Tesla Motors
Money Morning: Don’t Get Caught in the Market Crossfire
Pursuit of Happiness: Is Technology the Most Exciting Industry in the World?
Australian Small-Cap Investigator:
How to Make Big Money from Small-Cap Stocks
