A Bear Market’s Possibilities

It’s almost impossible for anyone to claim that we’re not in a bear market right now. Global share markets are tumbling and investors are running to safe havens like gold and bonds. Analysts are confident they know why markets are failing.

There’s too many seller and not enough buyers. It sounds simple. Usually the simplest answers are true. And it’s not just the obvious assets that are selling off, like commodities and oil. Even secure institutions like banks are hurting from constant selling.

The ASX 200 is down almost 10% for the year. Our more secure stocks, Australia’s big four banks, have fallen even further than the market. Banks are down more than 15%, with the exception of Commonwealth Bank of Australia [ASX:CBA].

Retail investors have always found it hard to invest in most market conditions. But right now it seems like everything is going down. This has forced many investors to exit the market to look for other opportunities. And there are definitely a bunch of them out there.

Gold’s possible rise

When market turmoil becomes too much, investor like to move their money into safer options. One of which is gold. The loose inverse relationship between gold and stock market performance is well documented. Below charts the price of gold ETFs against stock market returns.

Gold ETF against stock market

Source: Share watch

The graph is already pretty convincing. But a percent change in the stock market won’t represent the same inverse change in gold prices. Does it apply to our market situation right now? Maybe, gold had its biggest rally since 2009. Gold prices vaulted more than 5% on Thursday after more uncertainty spreads through the global economy.

Investors are becoming more anxious about banks and their performance. Profit growth is expected to be low by many analysts. Low interest rates are expected to further decrease banking performance. So if the banks are deemed as unsafe, for the moment, the people will rush to other means of security. Analysts are now telling clients to move more of their capital into gold. Julius Baer analyst, Carsten Menke told clients to ‘add gold to their portfolios as insurance, if things turn out really bad, there will be much more upside.

And with so much pessimism in the market, who is going to ridicule the recommendation of gold. Federal Reserve head, Janet Yellen has now joined the sceptics. Her short term view of the market is wavering to say the least.

She told the US Senate Banking Committee that negative rates weren’t off the table. Meaning the Fed is not ruling out decreasing interest rates after lifting them as recently as two months ago. But things have gone too far. Negative rates won’t reverse current share market trends right now.

Gold might be the one safe haven that sellers won’t touch right now. They will instead continue their rampage on equities.

A government sell off

In the last few weeks there are two prices that analyst have been taking more interest in. China’s yuan and oil prices.

It was supposed to be the Asian century. I doubt anyone would have predicted things to go so badly for China. Their stock market catastrophe mid-2015 was harrowing enough to last a while. Yet China now has problems with their currency and capital leaving the country. Both problems are interconnected so far.

As the yuan depreciates, more Chinese citizens want to invest their money internationally. Selling the yuan to buy foreign currency to invest internationally further decreases the yuan. And it creates a viscous cycle. The currency depreciates more, and more people move their money out of China, and then the currency depreciates more.

The depreciating yuan is putting immense pressure on China’s imports. Now that the yuan is worth less, China has to fork over more money to buy the same amount of goods. But we need to take population growth into account. The population is growing therefore more imports are needed. This causes further costs, dragging down China’s balance of payments.

China’s central bank has now resorted to drastic measure. Their plan is too sell US assets and the US dollar in order to buy the yuan. Their efforts are producing minimal results. However China is also using foreign reserve as extra funds to buy more yuan.

China’s central bank has now burned through more than $400 billion in foreign reserves. And there are concerns that reserve stock piles might fall short. But as long as it’s in China’s best interest, the selling of US and global assets will continue.

China isn’t the only seller; oil producing nations are also selling off their shares of global assets. And all because of low oil prices.

For countries like Saudi Arabia and Norway, oil is a big part of their exporting business. The shock of the oil price dipping below $27 per barrel has scared them into selling.

First to be hit by the selloff was the European banks. On Monday investors were baffled by plummeting bank shares. Banks across Europe have shed almost 20% this year. The selloff was aimed at plugging up budget short falls for oil nations. And once Europe was affected, banks all over the world joined in the decline.

Our Australian banks dropped by more than 5% at the start of the week. Not even Australia could shake off the negativity that has infected markets globally. Aberdeen CEO, Martin Gilbert stated ‘sovereign wealth funds were set up for a rainy day and that rainy day has arrived.’ It seems logical. But it wasn’t the only reason banks were hurt by oil.

Many oil producing companies globally and here in Australia have been borrowing to say afloat. Producers like Santos and Woodside have taken on billions. Dividend payments and dwindling cash supplies are the catalysts for the increase in debt.

Time will tell if oil will make a sustained rebound. Until then, the market will have two aggressive sellers, China and oil producing nations.

Why a bear market isn’t all that bad

Every time Warren Buffett lays his head on his pillow I’m sure he dreams of bear markets. Buffett loves bear markets because he’s a value investor. He simply values companies based on their future profitability and likelihood to succeed. The trick part is the valuation of the company.

Many investors use different formulas or equations. It’s not all factors and figures though. Buffett always preaches investment in businesses not stocks. He seems to have picked it up from his mentor Benjamin Graham. This idea gives investors some room for discretion.

The investor should invest in businesses they know. They should value these businesses according to their success in the industry and wide macro performance. Right now the ASX 200 is considered a bear market. As I stated before, the ASX has dropped almost 10% this year and things are picking up.

This shouldn’t frighten investors. Instead it should make them feel lucky that the market has presented stocks for rock bottom price. Now every stock that experiences a major dip is considered cheap. A stock is cheap when you can buy it for less than its actual worth. And since stocks reflect businesses, the business must be able to create value for the investor.

The market is a scary place. A lot of investors end up losing money because they get scared and sell out of their holdings. But if you’ve done your research and valued a company appropriately then a declining market shouldn’t scare you. It should make you want to buy more.

If you bought into a stock and then the market plummets, that stock is now even cheaper than it was before. A lot of investor just don’t understand timing. The market is correcting itself all the time. If you’ve managed to buy into a stock which is cheap then hold on. Unless you’ve done your calculations wrong that stock will correct itself and your position will become profitable.

But the general message here is to look out for opportunities. Gold may be one but don’t discount equities as a source of income. You might be able to buy some great companies for bargain prices.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Investing in a declining market is hard. If you think you’ve got a great company the market may give you a rude awakening by showing its faults. That’s why you should only invest in value. This means the market cannot sway you if you’ve identified a company that can create future value.

According to Money Morning’s Publisher Kris Sayce, there are five great ASX stocks for 2016. In Kris’s report ‘The Five Best ASX Stock for 2016’ he will reveal the five must by stock for 2016. There’s a sneaky way to play the Australian property market. And retailers are getting ready for a revival.

Kris will reveal all in his report. To get your free copy today, click here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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