The Year of the Stock Picker

In yesterday’s Markets and Money I mentioned that even a well-diversified portfolio went backwards in 2015. I based that on data from US asset markets. But it’s representative of Aussie markets as well.

I’ll get back to that in a minute. But first, what happened yesterday in China? The stock market crashed 7%, forcing a trading halt on the Shanghai Stock Exchange. There was a weaker than expected manufacturing sector release at the start of the day but that wasn’t the reason behind the sell-off.

The bottom line is that the Chinese market remains extremely fragile and prone to panic. It’s an artificial market, supported largely by government edict.

From an economic perspective, it’s China’s transition from a commodity intensive to services led economy that is causing problems. The shift is leaving behind unemployment and increasing debt burdens.

This latest sell-off may or may not prove fleeting. But 2016 is going to be another year of worrying about a Chinese hard landing.

And for Australia too. The bottom line is that Australia derives a large portion of its income from exporting bulk commodities, and commodities in general. Unfortunately, as we start the New Year, there are not any signs of improvement.

An article in the Financial Times reports on the perilous state of the global dry bulk shipping industry:

China’s slowing growth and a glut of ships have hit earnings for vessels carrying coal and other dry bulk commodities so hard that owners face forced sales, emergency capital raisings and possible bankruptcy.

Charter fees are not covering vessels’ operating costs, let alone their financing, in the latest bad news for the many private equity firms that have invested in the sector.

Short-term charter rates for Capesize ships — the largest kind — were as low as $4,897 a day on December 23, down from more than $20,000 a day in August. Vessels typically cost around $13,000 a day to operate and finance.

The Baltic Dry index, which measures overall average charter rates, has been at its lowest levels since it started in 1985.

This reflects a structural change going on. China’s intention is to be a ‘service’ led economy, rather than commodity intensive. That means future shipping volumes of bulk commodities won’t play out as expected.

On top of this, years of easy money have facilitated increasing supplies of large bulk carriers. Now the market must endure a painful adjustment to create a supply and demand balance again, and to deliver profits for the industry.  That will take some time.

I mentioned earlier that even a well-diversified portfolio didn’t do much in 2015. The only positive from an Aussie investor’s perspective was the benefit from a falling dollar. Even though I think the Aussie dollar will fall heavily again this year, betting on currency movements to juice your returns is a hard game to win consistently.

If you want to bet on currency movements, do so as a part of your cash allocation. Instead of putting all of your cash eggs into the Aussie dollar basket, consider diversifying into other currencies. There are a number of currency ETFs listed on the ASX that will help you do this.

Because of last year’s poor return from a standard diversified portfolio, predictably, this year the experts are telling you to do something else. For example, yesterday’s Sydney Morning Herald had this headline: ‘ASX: Forget the index, 2016 will be a stock picker’s market’

How they know this I have no idea. Perhaps 2016 will be a stock pickers market. If so, that will be great for our business. Newsletter writers are stock pickers. They ignore the index and only recommend investment ideas that have the potential to outperform.

But keep in mind you see headlines like this because of what has just happened. When it comes to predicting the immediate future, we do so by looking to the immediate past.

To see what I mean, check out the introduction to the SMH article.

This year is set to mark another challenging year on the ASX amid low interest rates and low economic growth, fund managers say.

After a dismal 2015, investors must change their strategies to enjoy some returns this year, Australian Unity chief investment officer David Bryant said. “Whatever you’ve been doing isn’t going to work; it hasn’t been working for some time,” he said.

Prolonged low commodity prices and demand from China, as well as low interest rates and economic growth depressing company earnings, will mean 2016 will not be “an outstanding year” for growth in the S&P/ASX 200, he said.

“Therefore, we can expect Australian equity returns to be muted.”

I agree with this general sentiment. I think it will be another lacklustre year for the market. But I also know that is just my opinion. And I know that the market doesn’t give a hoot about my opinion and could do absolutely anything.

Don’t forget 2016 is a presidential election year in the US. The US stock market has historically performed well in election years, irrespective of how the economy looks at the start of the year. A notable exception was 2008. That didn’t turn out according to the script.

In an election year you can expect the Federal Reserve to be very gentle on the interest rate front this year. They will err on the side of caution and leave rates on hold if the economy continues to look lacklustre.

As will the RBA. Although the Aussie economy is faring well, big falls in the price of coal, iron ore, oil and gas will continue to hurt the economy this year. That means the RBA will be more inclined to cut interest rates than to raise them.

That should help put a floor under the market. But I don’t think it will send stocks in general soaring. Some stocks will still do well of course. So yes, expect 2016 to be the year of the stock picker.

Greg Canavan,

For Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:

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