Watch this Crucial Market Reaction

The power of anticipation — the anticipation of tax cuts — sure is strong right now. Yesterday I mentioned how the market’s relentless push higher was human psychology at work. I quoted from a paper written by market psychologist Richard Peterson that is worth repeating (with my emphasis added):

Investors often gamble both on an event outcome and on the anticipated price appreciation as a result of that positive outcome. Anticipation of reward generates a positive affect state. Positive affect motivates both increased risk-taking and increased purchasing behaviors. As the anticipated potential reward approaches in time, investors’ positive affect is increasingly aroused. Following the delivery of an expected reward, investors’ affect regresses to neutral. This post-event net decrease in positive affect leads to more risk-averse, protective investing behaviors such as selling (consummate with the new, less positive, affect-state).

Overnight, the anticipation of tax cuts pushed US stocks to fresh record highs. The NASDAQ index hit 7,000 for the first time.

In Australia, the ASX 200 looks like breaking decisively above 6,000 points. This has been an area of resistance for years.

This is bullish, but with one caveat. I’ll get to that in a moment.

Merger and acquisition activity is pushing the Aussie market higher right now. Yesterday saw US tech giant Oracle make a $1.6 billion takeover bid for Aussie construction software firm Acconex [ASX:ACX].

That’s a lot of dollars flowing into the Aussie market (which will be deployed elsewhere) in one deal.

The deal is a bittersweet one for me. I recommended ACX to my Crisis & Opportunity subscribers just a few months ago. We got in around $4.90. At Oracle’s offer price of $7.80, it makes for a 60% return in a little less than two months.

It was a classic Crisis & Opportunity stock pick. That is, it had fallen heavily, but was coming back into favour. The trend had turned. And ACX was a company with an impressive product and global growth ambitions.

I was looking forward to good long term growth from ACX. But now it’s been gobbled up, as so often happens with promising Aussie companies.

Oracle has paid a full price for it. But in 10 years’ time, it could well be a bargain purchase. 

Contrasting Australia with the US

That’s the difference between US and Aussie companies and investors. The US is more strategic, whereas the Aussie market has a much greater focus on value.

For example, ACX was one of the most shorted stocks in the market. That means plenty of fund managers thought it was too expensive and would fall in price.

Superficially, ACX was indeed expensive. Profits and profitability were low compared to the pre-bid value of nearly $1 billion. But sometimes you can’t value stocks based on traditional valuation measures.

The key with ACX was to understand that it was investing heavily (and sacrificing short term profits) to build a dominant global position in the global infrastructure and construction market.

It was all about the ‘network effect’. That is, the more that companies use its cloud based project management software, the more valuable it becomes, as it encourages other industry players to use it too.

Network effects are very powerful and a key narrative driving the share prices of tech stocks like Amazon, Facebook and Netflix. So it’s important to understand that it doesn’t matter what you think about valuations with companies like these. It matters what the market thinks.

And at this point in time, the market places great value on companies with ‘network effect’ business models.

Who knows how long that will last? At some point, the network effect must deliver value in the form of bottom line profits.

But in the meantime, Oracle’s move on ACX will shine a light on other Aussie tech companies and push their share prices higher.

This is how bull markets work. A company with plenty of cash comes in and values another company much higher than the market does. The market then looks for similar companies in the belief that ‘everyone’ knows these companies are now worth ‘X’.

That’s when you see stupid prices paid for acquisitions, and lots of capital destroyed in the ensuing bust.

I don’t think we’re at that point right now. But I do think US stocks are stretched and vulnerable to a short term correction. And as I said yesterday, that correction could come about as soon as the US tax cut rumour becomes fact.

The Republicans hope that will be Tuesday (tonight Australian time). So watch for the market’s reaction immediately after, and especially from 1 January when the tax cuts take effect.

This reaction could well take the wind out of the Aussie market’s sails for the time being.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really 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. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. 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 basic, costly 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 Money Morning 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:


Leave a Reply

Your email address will not be published. Required fields are marked *

Money Morning Australia