Whenever, I have asked many of my successful trading peers – hedge fund managers, proprietary traders and wealth managers – what is the most common mistake traders make the most common response I receive is they are unaware of type of market environment they are trading in.
What is meant by this? Well I have seen it too often that within a bull market, too many novice traders are focused on picking tops and when the next “crash” will come. Likewise in a bear market, traders suddenly are looking to buy stocks somehow seeing value in just a small market decline and then holding on in the hope their investments come good. And finally when markets are directionless investors need to reduce their holding period for trades as profits quickly turn to losses in a volatile environment.
It may seem simple and basic, even obvious but given 80-90% of traders lose money, maybe it isn’t so basic.
So what kind of environment are we trading in now?
Well for the past two years the Federal Reserve embarked on a third quantitative easing program driving the S&P 500 into record territory from early 2013. As a result of the Federal Reserve’s immediate QE programs post the GFC, the US economy has improved at a greater rate than its global peer with markets now focusing on when interest rates may increase. Europe has finally embarked on its own quantitative easing program and the German DAX has rallied 20% since mid-January.
Unfortunately for Australia, the past two years has seen the RBA reluctant to join the monetary easing trend (until recent Feb rate cut) and our stock market has been a long-term underperformer on a global scale. The rest of the world has looked at Australia as one that is largely irrelevant, a proxy to China’s prospects and one with very little prospects for improvement. Since 2013 the gains of international markets can be seen below:
• Japan +88%
• Germany +57%
• S&P 500 +50%
• China +70%
• ASX 200 +25%
The lack of RBA support has been the single most important factor for our underperformance. This is emphasized even more when the gains of the ASX 200 since the RBA cut rates in February are stripped out, thereby reducing the performance to a measly 20%.
The change in RBA policy to join the global monetary easing policy is a significant change. This transition resets investor outlook and expectations for the economy and profits and creates a major alteration in fund flows. Large short positions are covered, fresh new buying on subsequent changes in valuations and switching from bonds into higher yielding equities.
For traders this transition to a supportive monetary policy means a significant re-rating like that witnessed in global markets. Importantly, unlike 2013 and 2014 where breakouts failed (see below), breakouts now are evolving into sustainable trends and quick gains can turn into longer-term profits.
ASX 200
As a result there are two key thematics that I see persisting for the foreseeable future:
1) Companies with significant offshore earnings will be re-rated higher on the combination of a weaker Australian dollar and the improvement in offshore economies, particularly the United States
2) The chase for yield. Lower deposit rates and bond yields is forcing investors to consider “riskier” assets that produce higher returns. Banks, infrastructure and property trusts are the primary beneficiaries of this trend.
The best action point traders can now make in consideration of the above is to buy the four banks that are cum-dividend – Bank of Queensland, ANZ, Westpac and NAB. I know this doesn’t seem to be an exciting or even innovative idea however, it’s hard to argue with timing and history. If boring makes money then call me boring!
Below is the Financials Index and we have highlighted the mid-March to early May period of the past two years. Over this period all the above four banks will announce their profit results and pay dividends. With the 45-day holding rule in order to claim the franking credits, “yield chasers” typically begin buying in mid-March. It is clear to see that there have been some strong capital gains during this period over the past two years. In fact this has occurred each of the past 4 years. The capital gains prior to ex-dividend have been:
• 2011 – +11.5%
• 2012 – +6.6%
• 2013 – +10.7%
• 2014 – 10.2%
So with this seasonal impact combined with a trading environment where chasing yield is stronger than ever and Australia has finally enjoyed the easing monetary policy trend, the gains in the banks due to pay dividends in the next two months have significant upside risk to the potential of 10-11%. It’s hard to buy record highs but that’s exactly what needs to be done as this is the environment we are now in. Like the S&P 500 in early 2013.
