Key points
- High frequency and algorithmic trading has exacerbated the swings/volatility in what is arguably nothing more than a vanilla equity market correction.
- Yield alone should support Australian banks at, or around, current smashed up share prices.
- Focus on the future and take advantage of September’s seasonality (weakness).
In the 11 times since World War II that Wall St fell 5% in August, it continued to fall in September 80% of the time for an average decline of another 4%.
Market history is not necessarily a guide to future performance but you’d have to think this September is a genuine chance of repeating history, as the Fed edges towards its first rate rise in nine years.
Clearly, we are in the midst of a China-led global growth scare. Global growth forecasts are being revised down, led by negative Chinese GDP growth revisions and their knock-on effects globally.
On the back of that, we are seeing equity earnings growth forecasts being revised down for the year ahead. This is evident domestically and globally.
Others are worried about deflation, while an outlier bear camp are worried that central banks are “out of bullets”.
Volatile times
After a period of extremely low equity market volatility, volatility has returned with a vengeance in the last few weeks. The VIX “fear index” index has spiked and remained elevated, which is quite different to previous market corrections.
The VIX isn’t predictive, in fact, many judge it as a reverse indicator and contrarian trading signal, but the fact it has remained elevated does suggest traders are genuinely worried about what comes next.
VIX Index last 12 months
[1]The VIX does seem to swing between a “complacency index” and “fear index”. Right now, it’s a “fear index” and you can see that “fear” reflected in what has happened to domestic and global equity indices over the last two weeks.
To be fair, there is plenty to be “concerned” about, but is it really the time for outright “fear”?
Personally, I think it’s a touch late to be “fearful” after the correction we’ve experienced. I think it’s a time to be “conservatively constructive” as Mr Market pays you a greater equity risk premium to take a risk.
No doubt prices could fall further as technical and sentiment factors collide, but I suspect what has concerned all investors is just how quickly we went from “calm” to “storm”.
Fast forward
The speed of this correction has been stunning. However, I think this is the new normal in a world dominated by instant information (aka the iPhone effect) and markets dominated by high frequency trading/algorithms (HFT).
As you know, I’ve been anti HFT since it started. I think it’s legalised scalping. How any investor can have a faster speed to market is beyond me. Yet, regulators in the infinite wisdom continue to believe HFT has done a great job in “narrowing bid offer spreads”. Yeah, until last Monday when the Dow opened down 1100pts…
What most investors do not seem to understand is most of the best bids and offers in electronic dealing systems across all markets now come from non-banks. These are agency, rather than principal businesses, with very little capital behind them. Is it therefore a surprise they go missing/widen spreads when markets get disorderly?
We are now in an age of machines. In fact, it’s the age of algorithms running markets on a daily basis. These machines hunt down liquidity at any price or a price regardless of liquidity. On that basis, markets can, and will, continue to move in extreme ways to extreme levels, as we have seen in the last few weeks.
Don’t get me wrong, in no way am I blaming HFT/algorithms for the correction. My view is they have exacerbated the swings/volatility in what is arguably nothing more than a vanilla equity market correction.
Of course, nothing shakes up “amateur investors” more than high volatility. Professional investors handle volatility much better than amateur investors.
Opportunity in adversity
I continue to believe there is opportunity in volatility. It is in volatile periods that opportunities present themselves. Unfortunately, most amateur investors use volatility as an excuse to “do nothing”, but professional investors step up their portfolio turnover in an attempt to capture some of the short-term extreme moves. That is one of the reasons volumes tend to spike in volatile periods.
The other thing that “spikes” in periods of high volatility is “noise”. Have you noticed how the market goes down in “billions” and rises in “points”? Of course, a fall is far more newsworthy and sounds far more dramatic if it is reported in “billions” or even “trillions”.
We live in a world that reacts to the next “twitter headline”. The more shocking the better. My advice to you is to avoid as much “noise” as possible and focus on fundamentals and the future.
Ask yourself: what really changed in the last few weeks other than prices?
The key answer is concerns about the Chinese economy, but we are at the point of universal bearishness in all things China facing, while China concerns have even dragged the mighty Wall St into a correction.
Buy banks
Yes, as I said above, there are many things to be concerned about and markets could well go lower in September.
One thing I intend to do in September is add to Australian banks, as the CBA rights issue ends and the other three head towards their full year dividends in October/November.
Yield alone should support Australian banks at, or around, current smashed up share prices. It’s also worth remembering there are increasing risks of the RBA cutting the cash rate again later this year (sloppy GDP this week), which would further enhance the attractiveness of these prospective dividend yields.
– WBC bounced off $29.45 which puts them on 6.5% fully franked FY16 earnings and trading on 11.6x FY16 earnings
– NAB bounced off $29.71 which puts them on 6.7% FF FY16e and trading on 11.3x FY16e
– ANZ bounced off $ 26.91 which puts them on 6.8% FF FY16e and trading on 9.8x FY16e
– CBA bounced off $72.47 which puts them on 6% FF FY16e and trading on 12.6x FY16e
I realise it has been a tough period and the natural human response is to curl up in a ball. I can guarantee you as an investor that is not the right response to periods like this.
I continue to encourage you to buy this dip in high quality companies, both domestically and globally. I also encourage you to tune out to all the “noise” from experts/commentators etc. Of course, other than those who write for the Switzer Super Report.
Focus on the future and take advantage of September’s seasonality (weakness).
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.