Sharemarket sell-offs and corrections inevitably lead to a flood of stories about which stocks fund managers are pouncing on. It’s all good stuff, but less considered is how to profit from a recovery by buying the market, rather than stocks, during bouts of high volatility.
I expect the latest pullback, almost a 10 per cent correction, to linger for a while longer. The biggest threat is a big sell-off in United States shares, which is long overdue. Although our sharemarket is arguably back below fair value, it would not withstand a correction in the US, or in Europe, which looks more precarious after a run of weaker-than-expected data.
Investment bank UBS this week wrote that the Australian sharemarket is looking relatively oversold and that it is value on a forward Price Earnings (PE) multiple of 13.7 times consensus earnings forecasts, versus 14.8 times before the September and October sell-off.
It wrote: “While the risk-return trade-off for Australian equities is improved, one lingering concern in our view is that the global/US correction is still relatively shallow.” Even so, UBS maintained its 5,625 end-of-year target for the S&P/ASX 200 index.
Other experts expect the market to recover its lost ground. AMP Capital Investors chief economist Dr Shane Oliver last week wrote: “This is still likely to be just a normal correction rather than the start of a new bear market. Share valuations are already pushing well into cheap territory … the global growth outlook remains for okay growth, monetary conditions globally and in Australia look like they will remain very easy … and investor sentiment is starting to get bearish again, which is positive from a contrarian perspective. The lower Australian dollar will also help boost growth in Australia and eventually profits. So for these reasons, the correction should be seen as providing a buying opportunity.”
If the ASX 200 index rallies towards its previous peak of 5,679.5, investors who buy the market today would gain about 8 per cent in a few months, I don’t expect the market to bounce back quickly, but would not be surprised to see it head towards the previous high in the new year, provided iron ore stabilises and the US market’s mild sell-off does not turn into anything more serious.
The easiest way to capitalise on a market recovery is through an exchange-traded fund (ETF) over the S&P/ASX 200 index. A benefit of buying ETFs during a volatile market period is much higher diversification; exposure to a large basket of stocks rather than backing one or two.
Active fund managers will argue that bouts of high volatility are when they earn their fees – and that passive exposure (via) ETFs is the last thing investors want when markets tumble. That argument has merit for long-term investors, but those seeking faster gains from market recoveries will find appeal in ETFs.
The biggest ETF is State Street Global Advisor’s SPDR S&P/ASX 200 Fund (ASX Code: STW). It seeks to replicate the price and yield performance of the S&P/ASX200 index. The annual management cost is 0.286 per cent, plus brokerage fees for buying and selling this ASX-listed ETF.
Chart 1: SPDR S&P/ASX 200 Fund
Another option is the iShares S&P/ASX 20 ETF (ASX Code: ILC). It mirrors the performance of the S&P/ASX 20 index and is obviously more concentrated in the market’s largest stocks, which tend to hold up best in volatile periods – and sometimes recover first when new money is put to work.
Chart 2: iShares S&P/ASX 20 ETF
Those who are more bullish on the market at the current level might consider a margin loan or an instalment warrant over ETFs. I’m not a fan of leverage, given so many stocks already have high debt, and would not recommend this strategy. Still, sensible, modest gearing has its place for those who believe that in the medium term the bull market remains intact, despite the current pullback.
Much depends on the investor’s portfolio. Someone who already holds several top 20 stocks might find too much duplication with the iShares S&P/ASX 20 ETF. Holders of portfolios that are already badly overweight Australian equities might find the SPDR 200 ETF skews their portfolio even further towards this asset class and reduces diversification.
Nevertheless, both ETFs offer potential to capitalise on a decent cent gain in the next few months, if markets can stabilise and recover.
An ETF is not as sexy as picking a stock that has fallen 20 per cent and has potential for big gains from a recovery. But with bank deposits paying measly rates, putting excess portfolio cash into Australian equities at the bottom of the pullback seems a reasonable strategy for experienced investors who can trade this idea over the next 3-5 months.
Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their financial adviser before acting on themes in this article. All prices and analysis October 16, 2014.