How You Could Profit if the Aussie Market Falls 18%


It’s never easy to see your position go down.

You might’ve been up 20%, before stocks ripped lower this week. Now you could be down 20%. On a $10,000 investment, that’s a $2,000 paper loss.

It’s not the worst thing that could happen, right? Imagine being down hundreds of millions.

Could you bear the pain?

When asked in a 2009 BBC interview how worried he was about declines in his own holdings, Charlie Munger said, ‘Zero.

You probably know Munger as Warren Buffett’s right hand man. He’s long been the trusted chairman of Berkshire Hathaway Inc. [NYSE:BRK] and the voice of reasons in Buffett’s ear.

Munger holds around 5,000 class A Berkshire shares. Today, each one costs around US$301,000.

That means just a 10% decline in Berkshire shares would leave him hundreds of millions of dollars poorer…on paper.

As Munger said in the BBC interview (with my emphasis),

This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%.

I think it’s in the nature of long term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by say 50%.

In fact, you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.

I love how blunt he is.

If you can’t stand paper losses then you shouldn’t be in stocks to start with.

Even more important than roughing out the highs and lows, is seeing volatility as an opportunity rather than misfortune.

Let me explain why…

Could the Aussie market drop 18%?

For months in 2017, our market was flat-lining. It wasn’t until October last year that we made a strong push upwards.

To many, 2018 was going to be more of the same. Little movement from day to day, but an upwards movement over time.

And because the market was going up, investors wanted in. They didn’t want to miss out on what could be easy returns.

The lack of volatility not only lulled investors into buying indiscriminately. It also prompted some to take short bets on volatility. Meaning investors sold short the ASX 200 VIX, which is an index tracking the volatility of the ASX 200.

So when the VIX spiked 84%, not only did investors lose money on falling stocks, those short the VIX lost a whole lot more.

VIX spiked 84%, not only did investors lose money on falling stocks, those short the VIX lost a whole lot more. 09-02-2018

Source: Google Finance
[Click to enlarge]

For a moment there stocks looked to be going the way of bitcoin.

On Monday, the ASX 200 ripped down 100 points. The next day, it fell by almost 200 points.

We’ve managed to stabilise since. But you could see our market dip lower following the dip in US stocks last night.

Safe to say we haven’t seen the end of this global sell off yet. 

And that’s because, as bond yields rise, investors are moving cash out of a low yielding market and into higher yielding risk free bonds.

Dr Bob Baur of Principal Global Investors, which manages US$453 billion, agrees. He recently told the Australian Financial Review:

I’m guessing that this correction is over, but I would expect that when US 10-year bond yields head to 3, 3.10, 3.25 per cent, we’ll see a bigger correction later this year.

Between now and then the market will likely try to rally back to the highs, but I’m not sure it will make a new high because some investors who wanted to sell earlier in the year may take the opportunity to sell.

I wrote about this in yesterday’s Money Morning, which you can read here.

If US bonds potentially rise to 3.5–4%, the ASX 200 could potentially drop 18%. That’s assuming the yield premium for holding stocks is around 2.5%.

This kind of drop probably won’t happen over days or weeks. It’s more likely to happen over months. And in that time, I’m betting volatility will be here to stay.

But rather than lament over a lumpy market, it’s really a time to celebrate.

You’ll have the opportunity to buy more stocks at bargain prices. And you could top up on existing positions as they fall indiscriminately with the market.

You’d rather sit back and wait for things to die down?

Well, consider this.

Munger had three opportunities to repurchase Class A Berkshire stock since 1990. Those three times were 1998, 1999 and 2008.

In those 12-month periods, Berkshire dropped rapidly by 20% or more. Had Munger bought as Berkshire dropped in all three years, he would have made approximately 410%, 566% and 212% on his additional purchases.

Still not thinking of buying…?

Know what to buy

Of course you shouldn’t just buy any stock that goes down.

Many times, there are good reasons behind falling prices.

Maybe more competition is coming into the market. Or maybe a company has lost multiple contracts with a major customer.

But if you’re holding a high returning business that falls just because the market is falling, then you should probably consider buying more.

Munger could have doubled, quadrupled and quintupled his money buying Berkshire when it was oversold by the market.

You could do the same if the market continues to tumble.

Kind regards,

Harje Ronngard,
Editor, Money Morning

Editor’s note: Harje makes the argument above for the opportunities of volatility. If he’s right, and markets begin to recover after a correction, then you could do well by exploring his ideas above.

But not everyone at Port Phillip Publishing agrees that the market could recover so easily. Vern Gowdie of The Gowdie Letter has long argued that global markets are massively overvalued. If he’s right, and if this week’s falls are the beginning of the global crash Vern warns of, we could be in for far deeper falls than just 18%. Find out more about Vern’s research 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.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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