It has been a scary few weeks for stocks.
There has been almost non-stop talk of the so-called tech ‘bubble’; bursting.
Add to this the ongoing rumbles in Ukraine, worries about slowing growth in China, and the prospects of Australia entering a recession, and it’s no wonder stocks have fallen.
Even so, what’s the damage?
As it turns out, for most investors it hasn’t been much more than a tiny cut to the flesh.
In fact, since the start of the year the Australian S&P/ASX 200 index is still up 1.9%, and for all the talk of the tech bubble crashing, the NASDAQ index is down just 1.94%.
Should investors see this as a mild tremor before the big event, or should you just ignore the noise and get on with investing?
Here’s our take…
Your editor is in the final week of our three-week stint in Los Angeles, California, one of the earthquake capitals of the world.
According to recent reports, California is due a ‘big one’. This weekend saw an earthquake in Mexico that measured as a magnitude of 7.2. And the two weeks prior to our arrival here saw a number of small-scale temblors that some thought could be a warning sign.
A similar story has played out in the stock market. Investors are looking at all sorts of events and stories and wondering if this is the precursor to the big stock market crash.
If an 8% drop in the NASDAQ is your definition of a crash then that’s what you’ve seen over the past month. But an 8% drop isn’t that uncommon. The issue is what will happen next. That’s where the bearish investors have consistently gotten this market wrong.
Same views, different targets
To be fair, there isn’t that much difference between your editor’s bullish view and many of the ultra-bearish views you see.
That may seem like an odd comment. Your editor is calling for the Australian Share Market to more than triple over the next five years. By contrast our old pal Vern Gowdie has the market falling 90% from today’s levels.
So how can it be possible that our views aren’t that far apart?
The reason is simple: we both see big structural problems with the world economy. We both see that the current boom is simply a result of boom and bust policies (increased credit).
One day that will mean the boom will turn to a bust. We both agree with that. The difference is that your editor believes that the boom has only just started. As a result we’re betting on Aussie stocks to more than triple over the next five years.
One reason for that boom will be the rapid growth of China and other emerging markets. Keep an eye out for more commentary on this from our new emerging markets analyst Ken Wangdong.
On the other side, Vern believes the market is about to hit the skids.
Anyway, getting back to the 8% NASDAQ drop. It’s one thing to have a long-term view on stocks; it’s another thing to take advantage of what have so far turned out to be short-term dips.
This is why we believe it’s much harder to be a bearish investor in this market — it’s much harder to make the most of the volatility.
Here’s why…
Own stocks to boost returns
When you’ve got an overall bullish view of the stock market you can afford to sit through the short-term dips.
You get to cash in any dividends you may get from income stocks, plus you can use spare cash to increase your stock position at a cheaper price.
If the market then reverts to an uptrend then you also get the benefit of capital growth.
On the other hand, for short sellers to play the same game on the short side it means they either have to be always short — which means they’ll accumulate a losing position in an up-trending market — or they need to time the market by shorting and then buying back the stock as the market hits the peaks and troughs.
That’s not impossible, but it’s tough unless you use the right trading tools.
Of course, if you believe the market is heading south it’s hard to justify buying stocks. But it’s also worth asking, what if you’re wrong?
What if stocks don’t collapse?
What if the market continues to rise? Or what if the market even just goes sideways for a long time?
It’s worth asking that question because there can be a big difference between staying in cash and having a combination of cash and dividend-paying stocks. For a start, a cash investment will likely give you no better than a pre-tax 4% income stream.
Meanwhile, a good dividend-paying stock can give you a pre-tax income stream of 6%, 7% or even 8%. It’s why even if you have bearish tendencies, in our view it still makes a lot of sense to invest at least a small portion of your investable assets in stocks.
For most investors we recommend up to 50% in stocks. But even starting off with a 5% or 10% exposure in this volatile market is a good start. That’s especially so after stocks have sold off. It could make a big difference over the next few years as you look to build your wealth.
Cheers,
Kris
From the Port Phillip Publishing Library
The Daily Reckoning: Losing Confidence in the US Dollar
