In today’s Daily Reckoning I’m going to take on a controversial topic. I’m going to tell you why I disagree with my Publisher, Kris Sayce on his bearish call on the market.
But first, something a little different. Last week Kris and I sat down for a series of brief chats about a new investing methodology I’ve been using with great success. I’ll explain more as the week goes on, but each day you’ll be able to view our discussions on the DR’s Facebook page. Check out the first instalment below, and be sure to ‘like’ it:
Now, back to the controversy! Well to be clear, it’s not controversial because I’m contradicting my boss’ view. This business is built on independent thinking and analysis. Frankly, you should be worried when everyone starts agreeing here. The company doesn’t have a view — only the analysts do.
Rather, I think it’s controversial because Sayce has been spot on about this market for years. He called this bull market early and has ignored the corrections.
Until now. Kris has gone from bull to bear and is concerned about a major correction. It’s the most bearish that I’ve seen him. You can read his latest on it here.
There’s a lot of lot of evidence on his side. And being of a bearish persuasion, I can easily see how the bearish argument makes a lot more sense than the bullish one.
That’s especially the case after what happened last week. On Friday, the ASX 200 lost 124 points, its worst showing since 2012 apparently. The banks (and ANZ especially) were smashed as the market all of a sudden realises they are ex-growth and in need of capital.
That’s not a good combination. No growth and more shares on issue…who wants that? Given the big four banks represent about a quarter of the entire market, it’s fair to say they will be a drag on things for the time being.
So yes, the bearish argument makes sense and the market is confirming it.
But my take is not a bullish one. So I’m not in complete disagreement with Kris. Instead, my view is ‘why have a view’. It’s neither bullish nor bearish.
Let me explain…
The ASX 200 is not even down 10% from its March highs. The market is up over 40% from 2012, so a 10% correction or more isn’t out of the ordinary.
If you react and sell now on what might be a 10–15% correction, you have panicked for nothing.
But what if this turns out to be THE crash, you think. Wouldn’t you be better off selling now?
Well, yes. But how do you know? How does anybody know?
That’s the bottom line. No one knows the future. More to the point, there are few historic parallels for this market. Never before have we been in such an interventionist period in terms of central bank market involvement. Absolutely anything can happen.
That’s why I think having an opinion is dangerous!
Now I don’t mean that you shouldn’t have an opinion at all. But you shouldn’t punt your portfolio on it.
That’s why I’ve come up with a different methodology. It involves testing your opinion against the market. If the market tells you you’re wrong, accept it and alter your view.
I call this the ‘fusion method’ of analysis. It works with markets in general or stocks in particular. I use fundamental analysis to build a story and derive a personal opinion on the outlook for a market or stock. I then ‘fuse’ this with charting, or technical analysis, to test my opinion against the market’s view.
While charting analysis fascinates me, I’m no expert. Quant Trader’s Jason McIntosh is, and contributes to this process by lending a hand with the charts.
There are a hundred different ways to read a chart. We make it simple by focusing on the underlying trend. Is the trend bullish or bearish? If the trend is bullish, then you should be too. If it’s bearish, then get out of stocks. It’s pretty simple.
Let me show you how the method works in relation to the ASX 200, and why I’m not prepared to turn bearish just yet.
The chart below shows a five year weekly chart of the ASX 200. I want you to focus on the blue and yellow lines, which are the 50 and 100 week moving averages. Moving averages smooth out volatile price movements, and therefore give you a good idea of the underlying trend.
Weekly charts, as opposed to daily charts, give you a great view of the long term underlying trend. Notice in the chart below how the 50 week MA (yellow line) is above the 100 week MA (blue line).
It tells you that the long term trend remains bullish. So from a longer term perspective, we are simply in a standard correction/consolidation period right now. It’s nothing out of the ordinary.
But it would be concerning for the bulls if the yellow line crossed below the blue line. That would warn that a long term shift in trend is possibly underway.
Which brings me to the next chart. This shows the ASX 200 over the past year, on a daily (not weekly) basis. Daily prices give you a better idea of the short term trend.
As you can see from the chart, the Aussie market is in a short term downtrend right now. The crossover of the moving averages in June signified this change in short term trend.
Now that event itself is not out of the ordinary. It happened last October for a few months too and the market soon went on to make new highs.
But the fundamentals are different now, which makes me more cautious about this recent downtrend. It looks like the banks’ strong growth phase is over and now they need to raise billions in capital, which means more shares on issue and lower share prices in the absence of profit growth.
In addition, it looks like the RBA is reticent to cut interest rates again. I think they will have to eventually, but they need to see the housing market cool off before they cut again. That could still be months away, or not this year at all.
That means the market won’t get an interest rate free kick like it got late last year. So I expect downward pressure on the market for the time being.
But remember, the long term trend of the market remains bullish. That means it’s too early to get negative on stocks, even though it might end up being the right call.
What should you do then? The ‘fusion method’ tells you to let the market decide. Here’s how I suggest you play it…
Even though the fundamentals look bearish, stay neutral for the time being. If the ASX 200 continues to fall, and breaks through last years’ lows around 5,100 — it will be a very bearish sign. It will tell you that the long term trend is in the process of turning from bullish to bearish.
The tide, after coming in for years, will be on its way out. It’s at this point that you should radically alter your strategy. Swimming against the tide is a fruitless exercise. So is buying stocks in a bear market. In a bear market, cash is king.
Even though the ASX 200 must fall another 7% or so before confirming a bear market is upon us, you’re better off risking this 7% rather than making an emotional call to sell now.
While you might think a bear market is on its way, it might not be! This may just be a standard correction. After all, we’ve had a few in this bear market. Although there are plenty of risks around, there is still lots of liquidity and cash as an alternative remains fundamentally unattractive.
My conclusion? Don’t stress and don’t guess. Let the market make the decision for you. But when it decides, change your strategy quickly. Be decisive.
Tomorrow, I’ll show you how you can use the fusion method to buy (and sell) individual stocks.
For The Daily Reckoning, Australia