So, the Reserve Bank of Australia (RBA) has cut Australian interest rates to a record low 2.5%.
As we’ve explained all year, interest rates are going lower. And they will go lower than this. A cut to 2.25% is almost inevitable, and a cut to 2% is more likely than not. (Family wealth expert Vern Gowdie says rates will go towards 1%! You can read more from Vern below.)
You know what that means. The RBA continues to follow the central banking playbook.
So if you thought the stock market was already risky, it’s just got a whole lot riskier. Sadly, you’ve got no choice but to play along…
What we’re about to explain is important.
The key thing you need to focus on in this market is the concept of risk.
When we talk about the market being risky as heck and super volatile, most people immediately think of the negatives.
They think about falling share prices. They think about huge price drops such as those in 2008. But that’s only one side of risk.
Risk is two-sided. It has a positive side too. And if you don’t appreciate that you’ll miss out on the big gains that the stock market could give you over the next two years…
A Bad Year for Stocks? Think Again…
Think about it this way. When you buy a share you think about the risk of the share price falling. If that happens you’ll lose money. That’s bad.
But when you short sell a share you think about the risk of the share price rising. If that happens you’ll lose money (short sellers profit from falling share prices). That’s bad too.
In other words, depending on your investment, you view risk in a different way. What’s risky to one investor is a profit opportunity to another.
You should think about this when you look at today’s ‘risky’ market. Yes, there’s a risk share prices could fall if the Australian economy worsens. But there’s also the ‘risk’ that share prices could go up if – as we expect – lower interest rates and government spending provide a short-term boost to the economy.
The fact is when a market is this volatile there’s no telling which way stock prices will go.
You only have to look at a chart of the S&P/ASX 200 Index to see that stock prices have gone all over the place in recent months:
Source: Google Finance
Stocks have traded in a 10% range. That’s enough to qualify as a crash from top to bottom. And yet, since the start of the year, the Australian share market is up 9.8%. That’s a pretty good return by anyone’s standards.
We’ll say it again: just as there is the risk that share prices could fall, there’s just as much risk that share prices could rise. This is exactly what we told you when stock prices plummeted during May and June.
We told you not to sell. In fact, we told you to buy even as prices fell. We told you that if you ‘scaled in’ to the market by buying one-third or one-half of your normal position size you’d soon be in the black as the market recovered.
Don’t Bank on Rising Interest Rates
Today, the main index is within 100 points of the May top. Hopefully you didn’t waste any money on broker commissions by unnecessarily selling stocks since May (if you incurred broker commissions from buying stocks that’s a different story, that’s money well spent).
As we’ve mentioned before, we took a lot of flak from some folks who said it was foolish not to sell in May.
We took that view because we had a high degree of confidence we were right. The fears of rising interest rates just didn’t gel. It seems to us that it was a short-term readjustment of interest rates, to correct a position where rates had gone too low.
It was a simple reversion to the mean. But you shouldn’t assume interest rates will skyrocket from here, because we’re certain they won’t.
The fact that the Reserve Bank of Australia has just cut rates is more proof that the trend is for rates to stay low. The RBA still has more room to cut rates further, and we expect it to do just that.
As for the US, UK, Europe, and Japan, you shouldn’t assume rates will rise there any more than they already have. And you also shouldn’t assume the central banks will suddenly stop buying bonds – so-called tapering.
The markets are set to stay this ‘risky’ and volatile for many more years. You’ll see a constant stream of booms and busts where share prices rally and then fall. Opinions will change on the economic outlook and on the prospects for sustained lower interest rates.
But remember, Japan has experienced zero percent interest rates for 20 years. The US is only four years into its zero percent experiment…and Australia hasn’t even started its experiment yet.
The Positive Risk of Stocks
Ultimately a time will come when it’s right to sell stocks. But if you follow the relatively conservative approach we suggest of 20-40% of your wealth in stocks (mostly dividend-payers with some growth stocks) you’ll benefit if we’re right about Aussie stocks rallying to a record high in 2015.
We’ve outlined a strategy here that can help investors make big gains from this volatile market.
On the flip side this conservative approach also means you’ll have most of your capital protected should the worst happen and stock prices fall.
This market is all about risk. It was super risky in late May when most people said sell. Yet we told you to buy and stock prices have gained almost 10% since then.
In short, just because something is risky doesn’t mean you should think it’s a negative risk. When stocks shoot around as they have in recent months but are higher than where they were at the start of the year, it can be a positive risk too.
Cheers,
Kris+
From the Port Phillip Publishing Library
Special Report: The Sixth Revolution
Daily Reckoning: The Global Trend Towards Wealth Protection
Money Morning: Two Approaches to Investing…
Pursuit of Happiness: Learning to Avoid the Governments ‘Noble Wealth Trap’
Australian Small-Cap Investigator:
How to Make Big Money from Small-Cap Stocks
