Money-making lessons from a share correction

Sharemarket movements over recent weeks should reinforce to share investors a highly valuable lesson: don’t panic in a market correction – treat it as a potential buying opportunity.

Investors who followed this stance from the beginning of the correction in mid-February to the market’s powerful fight-back should be well rewarded for their opportunistic, unemotional approach to investing.

During the correction, the S&P/ASX 200 Index fell from a 10-month high of 4938.4 to a low of 4528.7 within days of the Japanese earthquake and tsunami.

And then share prices came powering back with a speed that has taken even long-time market professionals by surprise. At the time of writing, it had recovered almost 90% of the price fall.

And fund managements and equity strategists interviewed by SmartCompany expect the Australian market to keep rising in 2011 – albeit with some corrections along the way.

Investors who did panic sell during this correction are likely to pay a high price. They may have unnecessarily triggered capital gains tax (CGT) and incurred transaction costs. And they will probably have to pay higher stock prices to re-enter the market.

Prasad Patkar, portfolio manager with Platypus Asset Management, describes the Australian market as resilient considering “what has been thrown at it” from late December. “We have had floods in Queensland, earthquakes in Christchurch, then the disasters in Japan, and war in the Middle-East and North Africa.

“What [often] happens with natural disasters and wars is the knee-jerk reaction is to sell everything and take risk off the table,” says Patkar.

But Patkar believes that investors who are able to hold their nerve – and provided no far-reaching economic damage has occurred – such events can turn into good buying opportunities. He agrees that this correction highlights the dangers and wastefulness of panic selling.

And Dominic McCormick, chief investment officer of Select Asset Management, adds: “We very much saw the correction as an opportunity to increase exposure. Ninety nine times out of 100, markets overreact to these types of events – particularly when there is uncertainty around.”

David Cassidy, chief equity strategist at UBS, continues with this theme: “We certainly weren’t telling people to sell. We were pretty clear [to clients] that it was a buying opportunity.”

Other pointers for investors as the market emerges from its latest correction include:

1. Don’t be frightened by corrections in cyclical bull markets

Apart from creating buying opportunities, Dominic McCormick of Select Asset Management says the latest correction returned a “bit of sanity” into the market.

“It is probably a healthy thing for the markets to have these types of corrections,” he adds. “If markets had kept going up in a straight line, we would have been getting concerned that bubbles would start to develop in some areas.”

2. Regard Australian stocks as inexpensive – if not cheap

As Cassidy emphasises, local stocks are trading on a forward price-earnings multiple of about 12 times – down from a long-time average of 14.5 times. He believes that local stocks are cheap.

Patkar regards local stocks as “inexpensive” while McCormick comments: “I don’t think the market is cheap. But it is certainly not over-valued or expensive – particularly if the [economic] recovery continues.”

From a practical point of view, this means that cashed-up investors still have an excellent opportunity to put more money into this market.

One of the factors being analysed by equity strategists and fund managers is why the Australian market has significantly underperformed the US and most global markets over past six months.

Cassidy and McCormick point to the impact of the high Australian dollar on the performance of the local market. And McCormick also points to the fact that our interest rates, higher than most countries, are drawing some investors away from the sharemarket – and he stresses that Australian political uncertainty has concerned foreign investors in particular.

Patkar says that while the high Australian dollar is partly responsible for the lagging performance of the Australian market against global markets, he believes China’s tightening of its monetary policy is “really weighing” on our market.

3. Consider outlook for local market once China’s tightening is over

Patkar expects that the Chinese Government will announce in two or three months that its monetary tightening is over. He then believes its economy is likely to accelerate in the second half of 2011 – with a positive impact for Australia’s commodity prices.

“As soon as the Chinese announce that they are more or less through with their tightening… you will see that our markets start to outperform,” Patkar says. “There’s nothing wrong with the Chinese economy; it is growing very robustly.”

If Patkar’s forecast eventuates, investors who increase their exposure before this boost to the Australian market should be well rewarded.

4. Pick stocks or sectors offering the most opportunity

“We are over-weight energy,” says Cassidy. “That is our key cyclical. The oil price has gone up a lot and we don’t see it correcting done very much in the short-term.”

“The energy sector in Australia has lagged [to date]; it hasn’t done much.”

Cassidy also favours the big miners. And he points to selective industrials – which have under-performed the market – naming such stocks as Asciano, Boral and CSL.

Patkar expects energy and material stocks to do reasonably well. “The large-cap commodity stocks will probably outperform the smaller-caps given that their performance has lagged,” he says.

He is understandably cautious about retail stocks given the reluctance of consumers to spend despite such factors as the high employment rate and the health of the economy.

McCormick believes that the resource sector “still has legs” despite its sustained out-performance to date.

“The better quality producing resource stocks don’t look overly expensive,” says McCormick, “as long as we are not going to see dramatic falls in [commodity] prices in the near-term.”

“If you take a view that the China/India growth story is going to continue reasonably strongly over the next few years, I think resources are still the place to be.” He favours the bigger diversified stocks such as BHP-Billiton and Rio Tinto.

5. Prepare for volatility and don’t overlook risks

There are, of course, plenty of concerns – such as widespread and unresolved sovereign debt – overhanging the market.

While McCormick believes that the market is likely to continue on its upward path, he says such concerns are likely to trigger corrections along the way.