Hopeful for a Shock but Not Betting on It

We don’t turn the other cheek when someone hits us. ‘In our culture, we punch back,’ China’s president, Xi Jinping said.

No way is China going to back down to America. They consider themselves the centre of the world, the oldest civilisation on earth. America is just 242 years old, a baby in comparison.

As you might have heard, America is not only taxing Chinese goods. They’re planning to limit Chinese investment into American businesses. A taste of China’s own medicine I expect Donald Trump is thinking.

In retaliation, China has held up US-China, ‘M&A deals involving US companies, delay licences, ramp up inspections or drive its one billion-odd consumers to shun American products,The Australian writes.

Rather than thinking about their citizens, Donald and Xi just don’t want to look weak. A battle of the egos you might say.

It has really turned into a tit for tat situation.

 

Why I’m hopeful for a major market fall

Analysts believe trade talks will get worse before they get better. Some have even suggested markets are not fully aware of the risks. It’s why The Australian wrote yesterday:

First we have a US share market that is priced on the basis that nothing will go wrong. Some call it a “hyper-valued market”.

Then, secondly, superimposed on that market is a sudden rise in risk aversion. The two are in conflict. This has happened many times in past decades and sometimes it’s a passing phase. Other times such a conflict leads to a major market fall.

When too many investors become risk-averse, cash becomes more important so reducing the forces that have boosted the share prices.

Once that starts to happen in earnest the effect multiplies and everything is turned upside down.

As I have seen many times in a boom market as we have enjoyed for many years, bad news is often turned into good news. And good news inspires the market to rise further.

When the proportion of risk-averse investors rises rapidly the opposite can be true and good news is turned into bad news and bad news causes large falls.

I for one really do hope you see markets come crashing down, although I’m not betting on it. Right now, stock pickers are having an incredibly tough time deciding what to buy. Hardly any of the major players in the All Ordinaries look cheap.

And because it’s hard to sit on your hands, investors are buying what’s cheap relative to everything else. Meaning anything trading below an average multiple is cheap.

 

 

Real estate is notorious for being valued on a relative basis. A recently sold three bedroom house in suburb XYZ is likely going to affect the perceived value of all other three bedroom houses within the area.

But do relative results really matter when values in aggregate can’t be justified. I’m sure you wouldn’t like a 10% loss in 2018, even if the market dropped by 20%.

Yet as I said, I wouldn’t bet on a sizable drop just yet.

 

Fingers crossed

Let’s forget about the market for the moment. The only way you’re going to see massive returns (in my mind) is if you focus on individual businesses.

I’ll use REA Group Ltd [ASX:REA] for example.

Many might consider REA Group a technology stock. They’re the owners of realestate.com.au and generate all of their sales online.

If, for some reason, investors start shunning the technology sector on the ASX, does that mean you should go ahead and sell REA Group too?

Of course not.

In most cases, it will probably be a great buying opportunity. But there’s a reason I choose REA Group for this example and not some other technology stock.

REA Group is an amazing business.

The company has built an incredibly strong platform. Anyone looking to buy property in Australia will jump onto realestate.com.au.

Being the property platform Aussies turn to has given REA Group incredible pricing power. They generate sales from advertising properties on their platform. It’s not all that hard to simply increase the price of posting an ad on their platform.

If sellers want to get their property in front of as many eyeballs as possible, they’ll pay up. You could say that REA Group’s future earnings are very certain. The only problem is the stock’s sky high price. REA Group trades at more than 65-times the average of earnings for the last five years.

That alone doesn’t make REA Group a no go zone. However, for REA Group to be worth the $12 billion it’s worth today, the company would have to grow earnings at a far higher rate than it has in the past.

Fingers crossed for that drop.

 

Your friend,

Harje Ronngard,
Editor, Money Morning

PS: Thankfully, there are still opportunities on the ASX. You just have to know where to look. According to Ryan Dinse, editor of Exponential Stock Investor there are massive opportunities brewing in biotech. He’s calling it Project: Shivom. It’s where biotech and blockchain technology meets to potentially create massive investment returns.


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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