That wasn’t supposed to be how the year began for stocks.
The script said that stocks should go up.
After all, didn’t the market just have a booming ‘Santa Claus rally’?
It did, but the market doesn’t always follow the script that investors write for it.
Sometimes, the market writes its own script…
‘Blue-chips are safe stocks’ — that’s the script according to most investors.
How did that play out yesterday? Here’s how:
- Commonwealth Bank of Australia [ASX:CBA] shares fell 1.3%
- Westpac Banking Corporation Ltd [ASX:WBC] shares fell 1.7%
- Australia & New Zealand Banking Group Ltd [ASX:ANZ] shares fell 1.4%
- National Australia Bank Ltd [ASX:NAB] shares fell 1.2%
- Telstra Corporation Ltd [ASX:TLS] shares fell 0.5%
Those are five of the market’s biggest and supposedly safest stocks.
Overall, the blue-chip Aussie S&P/ASX 200 index fell 0.5%.
How did your shares do?
These ‘risky’ stocks do it again
If your portfolio generally follows the direction of the big Aussie stocks and the blue-chip Aussie index, the value of your portfolio probably fell too.
But what’s the big deal?
A half a percent fall isn’t so bad.
Not when you compare it to yesterday’s 6% drop in China, and the 2.5% drop in Japan.
But not every stock fell yesterday.
While the market’s so-called ‘safe’ stocks took a bath, a different type of stock — so-called ‘risky’ stocks — went against the script.
They didn’t fall. They went up. Here’s the proof:
This is a chart of the S&P/ASX Small Ordinaries index. Yesterday, while blue-chip stocks lost 0.5%, the Small Ordinaries gained 0.1%.
Sure, it may not be a big gain. But the size of the gain isn’t the point.
The point we’re making is that the market doesn’t always go in the direction that most expect.
Conventional wisdom is that blue-chip stocks are ‘safe’. Conventional wisdom says that if you want a ‘safe’ and diversified portfolio, you should allocate most of your share portfolio to blue-chips.
But as yesterday’s market action shows, that isn’t always the best advice.
The danger of safety
What we’ve just explained is one of the biggest dangers, both for novice and experienced investors.
It’s what we call the ‘danger of safety’.
That may sound like a contradiction, but it’s important to understand it.
The ‘danger of safety’ occurs when investors become so convinced that an asset is completely safe that they willingly pay any price in order to own it.
Of course, no asset is so safe that it’s worth paying an infinitely high amount. But when investors believe an asset is safe beyond question, the distinction between paying a fair price and overpaying goes out the window.
Not only do investors pay ever-higher prices for the ‘safe’ asset, but because they unquestionably believe in the safety of the asset, they own more of it than they should.
For a time, their actions may appear to pay off…in fact, it usually does. That’s what causes them to keep buying more and more of the asset.
But eventually, the bubble (for that is what it is) pops. And soon, those investors realise their error.
It can happen with almost any asset. It happened to gold in 2011. It happened to Aussie blue-chip dividend stocks from 2012 to 2014. And eventually it will happen to the world’s major bond markets too.
That’s the ‘danger of safety’. It’s why for a long time we’ve advised investors to be careful of overinvesting in supposedly ‘safe’ stocks.
Instead, we’ve advised investors to have no more than 40% of their investable wealth in stocks. We’ve then advised investors to put some of their money in good dividend paying stocks. But we’ve also told them to look at some of the market’s riskiest stocks too.
The way we figure it is that, if the market does well, these tiny and risky stocks should do well too. But if the market falters or even collapses, then you’ve only allocated a small amount of your portfolio to these risky stocks.
There’s no doubt it’s controversial advice. But it’s advice we believe in. Our colleague Sam Volkering has pinpointed a number of small stocks that he says should be on almost every speculator’s buy list.
You can find out more about them here. Make no mistake, these stocks are risky. But based on how even the big blue-chips are performing, that’s something you can say about almost every Aussie stock.