This market will turn


The information in this article is market commentary only and reflects Lincoln's views and beliefs at the time of preparation, which are subject to change without notice. To obtain up-to-date information, please contact us.

Many share investors will currently feel like a cork in a big, wide ocean, where any chance of arriving at your dream island destination will be dictated by a combination of the winds, tides and chance. However, those of us who have been around long enough know that successful investing in the market is never smooth sailing.

It is true the sharemarket is a volatile beast. Over the past 12 months there has been a significant shift away from high-quality, highly priced businesses with strong financial health and consistent growth towards speculative, cheap (so-called deep-value) stocks.

Volatility and dynamic cycle shifts are part of the investing game and need to be embraced. Even when it doesn’t make sense, as is currently the case. As the world’s greatest investor Warren Buffett cautions us all, we ‘‘shouldn’t own common stocks if a 50 percent decrease in their value in a short period of time would cause acute distress’’.

This current market cycle has seen money make its way into high-yielding banks and financial businesses. This is understandable given their defensive nature, consistent dividend streams and share price weakness. But the more significant move of money has been towards stocks in the mining sector, in what can only be considered as ‘‘courage stories’’. Low price-earnings ratios and a turnaround in commodity prices resulted in investors becoming brave and attempting to get ahead of the curve. Investors went in early, picking the bottom and looking for deep value. This was exemplified by the S&P/ASX 300 Metals and Mining Index, which surged 53 percent last year, against a 7 percent rise in the All Ordinaries.

The trend has continued throughout the start of 2017, with a wide range of factors, including tweets by US President Donald Trump and Chinese stimulus programs, cited as reasons for the increased interest in commodities.

Yet most analysts expect commodity prices, particularly for iron ore, coal and copper, to be mixed in 2017. Iron ore stockpiles are at historically high levels, coal has seen supply pressures ease but this is unlikely to last, and copper has risen on the back of impending strikes at the world’s largest copper mine, Escondida in Chile.

It doesn’t take a mining analyst to tell you the above factors point to a disconnect between price and the fundamentals. Herein enter the speculators who have been playing commodity futures aggressively in places like China.

As investors, we have no control over such factors. Cycles come and cycles go. In 2016, commodity stocks definitely swam with the current.

But, as with all market cycles, it will turn. As Buffett also once said: ‘‘Only when the tide goes out do you discover who’s been swimming naked,’’ reminding us of the opportunity that lies ahead for quality businesses.

So, while you might be white knuckling the recent decline in those once premium-priced businesses, rest assured recent volatility has created a wonderful opportunity to buy great businesses at cheaper prices, as they too enter the value cycle. These stocks are primed to attract investors.

It just may not feel like it right now. Just remind yourself that no one can ever tell you when the bottom of any cycle will hit. But you will know when you miss it.Now is not the time to join the herd. Instead, stand against the tide.

Once the wave breaks it will be smooth sailing, until the next inevitable storm.

Wednesday 1 March 2017
www.afr.com| The Australian Financial Review