Three Reasons to Invest in This ‘Risky’ Stock Market

By MoneyMorning.com.au

Time flies when you’re having fun.

It might have snuck up on you, but the first quarter of the year is drawing to a close.

It’s been quite a ride for stocks.

If you feel like your portfolio’s been pushed from pillar to post, you’re not alone.

At this time of year, it’s a smart idea to take a step back and recap what the topsy-turvy markets have taught you over the past few months.

It’s the only way you can test that your investment strategy is still valid.

And it’s the best way to make sure your portfolio is primed for performance…

Right now, the S&P/ASX 200 index is more or less where it was on January 1st.

When you subtract the drag of inflation that means there’s only been one way to create wealth in the this market: stay active.

But that quarterly return of zero percent has masked a few thrills and spills.

Here’s a quick play-by-play.

By early February, the market had given up 5.3% as investors reacted to two teacup-sized storms.

The first fear was the emerging markets capital outflows (remember that?).

The second gripe was the distant – but apparently terrifying – ‘threat’ of slightly higher interest rates in Australia and the US.

I’m still mystified as to why some investors mark down shares today on this bogus basis.

If you ask the bears, they’ll insist that corporate earnings are imperilled by the prospect of marginally higher borrowing costs more than a year in the future.

Here’s what I wrote to you on that topic back in February: ‘…this isn’t news. The markets only worry about stuff like this when there’s nothing else to shout about.

I’ve seen no reason to change my mind about that.

Over the following month, the market rallied by 7.7% as a strong season of corporate earnings took investors pleasantly by surprise.

But since mid-March, the Australian stock market has cooled off a little.

There are three reasons for that. But none of them should keep you up at night. Here’s why you should still invest

The gas trade is more important to Russia than Europe

Firstly, there’s the tension around the Russian push into Crimea.

Russia supplies around 30% of Europe’s gas needs. About half of that – 15% of Europe’s total gas demand – travels through Ukrainian pipes.

Investors seem to have been spooked by the possibility that Russia might turn off Europe’s gas taps.

This chart shows European dependence on Russian gas. It’s raised a few alarm bells. And at first glance, it paints a pretty scary picture.


Source: Financial Times
Click to enlarge

But that chart, with all those high percentages, is misleading. Gas is just one of many components of Europe’s energy mix.

For example, gas provides just 7% of Finland’s energy. Sure, right now that gas is Russian, but according to Finland’s trade minister Alex Stubb, that gas could easily be found elsewhere if need be. And Finland’s European neighbours have similar flexibility on energy.

Would the lights go out in Finland…or even Germany…if Russian natural gas imports ceased? Probably not.

In any case, disruptions to the energy trade would hurt Russia – effectively now a petro state – more so than the West.

So you can pretty much ignore the argument that stocks face some catastrophic risk from interruptions to energy flows from Russia.

Mr Putin is too smart for that…and the smarter market participants have already moved on.

Bad management rather than systemic risk

The second reason behind the stock market’s retreat is investor anxiety around a perceived slowing of economic growth in China.

Sometimes it feels like China’s economy generates so many news stories that it’s impossible to keep track of what’s important.

Well, here’s a story that the market thought was important enough to push down the price of iron ore by more than 8%…and drag the Aussie market down with it.

I’m talking about the news that Haixin Iron & Steel Group is in dire straits.

Haixin is the largest privately-owned steel mill in China’s northern province of Shanxi.

The company is struggling to pay debts of more than $3 billion.

If you listen to the bears in the mainstream media, Haixin’s issues will trigger a wave of company collapses and derail the entire Chinese economy.

I don’t buy it.

If you scratch beneath the surface of Haixin, you’ll find a company that owes most of its problems to good old-fashioned bad management rather than systemic economic risk.

According to business magazine Caixin, the steel company invested in entertainment businesses, banks, securities firms, insurance companies and recreational centres for children.

Sounds to me like a recipe for disaster. If an Aussie steel company like Bluescope Steel Ltd [ASX:BSL] or Arrium Ltd [ASX:ARI] tried investing in businesses as random as that, the shareholders would put the board to the sword.

It strikes me that Haixin isn’t the canary in the coal mine for a Chinese economic collapse. It’s just a poorly-run company that will probably go bust.

The collapse of one steel company shouldn’t stop China overtaking the US as the world’s biggest economy in the coming decade. That should mean good news for investors who position themselves to benefit.

Interest rates to stay low for years not months

The final concern that’s causing some investors to worry is the fear that higher interest rates in the US are coming sooner rather than later.

They point to a statement that new US Federal Reserve chair Janet Yellen made last week.

Dr Yellen suggested that the interval between the end of the Fed’s unprecedented money-printing program and the first interest rate hike could be as short as six months.

When bond markets heard that, they fell out of bed.

But didn’t we cover this ground a month and a half ago? There’s a real sense of déjà vu here.

Let me be clear about this.

Interest rates will only go up after the US economy has grown healthily for an extended period…and not before. Whenever that happens. But it’s more likely to be years into the future rather than months.

And even if the Fed tapers its money-printing down by a few more banknotes per month, there’s still no end in sight for the program. So the ‘good times’ will keep rolling along for share investors. The Fed will make sure of that.

The sector that consistently beats the market

I’m not the first person to advise you to be greedy when others are fearful.

But when markets react so savagely and irrationally to issues that aren’t much more than a storm in a teacup, you don’t even have to get greedy.

You only have to do three things…

Take a deep breath.

Stay invested in the market.

And get exposure to Aussie companies that are growing profits strongly enough to make you wonder why you ever worried about unimportant stories from a distant corner of the world.

That means owning a core set of blue-chip dividend stocks. But it also means having exposure to the sector that consistently beats the large-cap indices by an average of 6.7 percentage points per year.

I’m talking, of course, about small-cap shares. These stocks aren’t risk free, but when stocks are this volatile it’s a perfect opportunity to buy them on the cheap while other investors panic and run for the exits.

Cheers,
Tim Dohrmann+
Small-Cap Analyst, Australian Small-Cap Investigator

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By MoneyMorning.com.au