Is There More Upside to the Aussie Market?

Your editor writes from the sickbed this morning *cough*, so don’t be surprised if we cut things a little short *sniffle*.

Looking at the Aussie market we’re wondering, will it break out higher this time?

If you look at the chart below you can see the market has put in another rapid gain:

It’s added about 5% over the last six weeks, taking the index close to the recent peak in January.

But as I’ve told subscribers to Australian Small-Cap Investigator and Australian Wealth Gameplan the market is just as risky today as it was one year ago. The only difference is that stocks were much cheaper back then.

That’s why, in both newsletters I’m pretty comfortable with only having a few positions open. Sure, there’s a chance this market could take off. But there’s an equal chance it could crumble. So, after a 50% move in the index in the space of a year there’s nothing wrong with taking some of your exposure off the table.

And that goes for whether you’re a small-cap, large-cap or income investor.

And we’ll also guess it’s the same for traders as well – although we haven’t been able to ask Slipstream Trader editor Murray Dawes, as we’re quarantined at home.

I’ll be honest, it worries me when I read stories such as the one in the Sydney Morning Herald recently: “Plenty of force left in the bull”.

According to the subhead, “The sharemarket has charged 54 per cent higher in a year, and it’s still not too late to join the party.”

It’s got something of the “buy property before it’s too late” ring about it.

Take the quote from Lucinda Chan at Macquarie:

“We’ve had a positive earnings season with very few letdowns and there are some profit upgrades on the way through for quality companies… We’ve had some wonderfully uplifting data from China, the job news and business confidence is strong. I think the overall market is turning upwards again.”

Maybe she’s right, who knows?

The main problem I have with the ‘stronger for longer’ approach of the mainstream analysts is that it ignores investor psychology.

Look, we can barely spell psychology let alone understand it. But when we look at the longer term chart for the index we start thinking about the risk/reward payoff.

Take a look at the ten-year chart for the S&P/ASX200 index below:

Obviously you can see the massive bull run between 2003 and 2007 which took the index from under 3,000 points to nearly 7,000 points in just under five years.

Already, since March last year the same index has moved from around 3,000 points to nearly 5,000 points. During the previous bull run it took the index about three years to cover the same ground.

In other words, using that previous move as an example, investors have locked up three year’s worth of gains in the space of twelve months.

That’s not a bad effort by anyone’s standards.

But that’s only half of what concerns us. Now take a look at the one-year chart below:

In actual fact, it only took around seven months for the index to cover the same ground. Five months later and the market is still at the same point.

And it’s that which concerns us. Let me explain what I mean.

Last October the index had locked away about a 50% gain. Annualised, you’re looking at around a 90% gain – give or take a few points.

Today that annualized gain is, well, it’s roughly the same as the seven-month gain from last October, about 50%. If the index is trading at the same level in six months time – which is entirely possible – then your annualized gain drops to around 33%.

And if the index is still at this level this time next year then the annualized gain drops even further to 25%.

Look, don’t get me wrong, that’s still a pretty good return. But don’t forget, you’ve only locked in that annualized gain of 25% if you had picked up the start of the run from March 2009.

If you take the Sydney Morning Herald’s advice and tuck in today, then your annual return is zero – assuming the market moves nowhere between now and March 2011.

Anyway, what I’m getting at is how likely is it that big institutional investors are going to risk leaving up to 50% gains on the market? I don’t think it’s very likely at all.

Especially not when many of them will have seen their bonuses slashed in 2008. And that will be fresh in their memories. The last thing they’ll want to do is give back a whole bunch of profits by staying overexposed to a market that’s already risen by 50% in such a short timeframe.

Let’s make no bones about it. We want the stock market and share prices to go up. We’d love it if shares only ever moved in one direction – UP!

After all, we write two newsletters every month offering stock tips. But we’re not so one-eyed that we can’t see the risks that this market holds.

Are there still opportunities? In our opinion, yes. But the idea that the whole market is undervalued, or as AMPs Shane Oliver puts it, “a long way from being described as overvalued” is far from accurate in our opinion.

We won’t say that top-of-the-market complacency has completely taken over, but some of the signs are there. Headlines in the mainstream press are a pretty good indicator of that.

That’s why, right now, it would be a mistake to completely exit the stock market.

But cutting back on your positions and using risk management tools such as trailing stop orders makes a lot of sense. In other words, give yourself some exposure to further upside gains, but don’t fall for the mainstream propaganda that it’s blue-sky all the way to a 7,000 point index.

Cheers,
Kris.

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