Overnight the US market rebounded, after a crushing blow the night before.
The Dow Jones Industrial Average gained 274 points. That’s 1.6%.
The NASDAQ added 83.4 points. That’s 1.9%.
Today, the Aussie S&P/ASX 200 index should be in good shape after falling as much as 75 points shortly after yesterday’s open.
As for crude oil, it’s down again. As I write, it’s trading at US$87.71.
Free Reports:
As I’ll explain to readers of Tactical Wealth (formerly The Denning Report) next week, the recent fall for oil is just the beginning.
If I’m right about the geopolitical manoeuvring going on behind the scenes at OPEC, the market will crush the oil price over the next 18 months.
But I’ll save the full details of that, and the stock tips to profit from it, for Tactical Wealth subscribers. And if you’re wondering how to subscribe to Tactical Wealth, I’m afraid you can’t right now.
We’ve closed the doors to new subscribers for the time being. I’ll let you know when we decide to accept new members. But that’s for another day.
Back to the market. Just where is the market today?
The answer is it’s in no-man’s land.
It’s neither a bull market nor a bear market.
Those who think the market will ultimately go higher are starting to worry that they could be wrong, and that stocks will fall.
Those who predicted the market will fall are wondering whether this is the big fall or whether stocks could bounce from here.
It’s enough to make you wonder why you’d bother investing in stocks at all. The market this year certainly hasn’t done enough to make our old pal Vern Gowdie change his view on stocks.
He’s had an all-cash asset allocation strategy for the past few years, since getting out of the financial planning game in 2007.
You can read why here.
As someone who thinks every investor should have money in stocks, to me, Vern’s position seems crazy…except…the longer the Aussie market goes nowhere, the less crazy it becomes.
Over the past five years, the Aussie S&P/ASX 200 index is up just 13.4%. That’s an average of 2.7% per year. That doesn’t include dividends. If you add in dividends, it’s probably another 4–5% per year.
That’s certainly better than the average return on a cash savings account. On an after tax basis, it’s probably close to double the return.
Over the long run, this seemingly small difference between cash returns and stock returns has a compounding effect.
For instance, a $1,000 cash deposit with monthly compounding interest, at an annual interest rate of 4%, will give you $1,491 after 10 years.
By contrast, $1,000 in a stock that pays a 5% dividend yield, and where the stock price grows as low as 2.7% per year (and where the dividend growth is the same low 2.7% per year), returns you $1,885 after 10 years.
That’s an 80% improvement on your return compared to cash.
But that’s not where it ends. If you can go one step further and reinvest the dividends rather than taking cash, after 10 years the total value is $2,126.
That’s a 129% improvement compared to cash.
It’s a no-brainer.
Or is it?
Vern’s view is that, based on the current market dynamics, it’s just not worth the risk.
It’s hard to argue against his point. The 129% improvement compared to cash assumes that the stock market gradually rises over the next 10 years.
But what if it doesn’t go up?
What will happen if today is the equivalent of November 2007? That was when stocks just started to turn down after reaching a peak. At the time, investment pros said the market ‘needed a small correction’. They said that stocks could fall 5-10%, but then they would rebound higher.
But they didn’t. Over the following 10 months, the stock index halved, and many stocks (especially mining stocks) fell much further. Some fell 90% or more…a few went bust, such as supposed blue-chip Babcock & Brown.
It’s nearly seven years since the Aussie market hit a peak. Buying stocks at that point hasn’t been a good experience for investors.
Of course, that assumes an investor only ever bought stocks once…right at the peak.
Most investors don’t do that. You buy at various times. If you’re a long-term investor, you buy when stocks look cheap. If you’re a contrarian investor, you buy when stocks look awful — such as today.
But when it comes down to it, it’s all about what type of investor you are and whether you have the stomach for the risk. Buying stocks is risky. There’s no getting away from that. But even in the riskiest markets, it’s possible to make some extraordinary gains.
Mining stock Rio Tinto [ASX:RIO] got a nice bump yesterday. Reports emerged that London-listed mining giant Glencore [LON:GLEN] had made a takeover bid for Rio.
Rio’s board say they have rejected the bid and that there are no ongoing discussions with Glencore.
Needless to say, after the bump, Rio shares have taken a dip today.
In reality, even with the takeover speculation it has been a bad year for Rio shareholders. The stock is only down 1.7% since the start of the year, but it’s down 11.3% in just over a month.
When the market looks a bit wobbly, institutional investors with an exposure to the resources sector will typically seek to sell ‘single story’ stocks and buy a diversified stock instead.
That’s why Rio and BHP Billiton [ASX:BHP] have held up remarkably well this year as the rest of the mining sector takes a pounding. Aside from the big four banks, the Aussie market is still a resources market.
No fund manager worth their salt can say they’re investing in the Aussie market but then ignore the miners. That’s especially true for foreign institutions.
They won’t buy into Telstra [ASX:TLS], Woolworths [ASX:WOW] or JB Hi-Fi [ASX:JBH] in any meaningful way, because they can get world-beating stocks in those sectors in their own markets.
But they can’t necessarily get exposure to world-beating mining stocks.
The trouble is, by bailing out of the non-diversified small-cap and mid-cap stocks, investors can miss the biggest action. Sure, you’re not likely to see the share price of a big diversified miner fall 40% in a matter of seconds.
But you’re also not likely to see it gain 40% in a matter of days either…or 300% in a matter of weeks.
That’s exactly what has happened with another good news story from small-cap analyst Tim Dohrmann. A small African offshore oil and gas stock, which has been on the Australian Small-Cap Investigator buy list for nearly three years, finally struck oil.
Based on today’s price, it’s up 340% on the recommended buy price. Almost all of that gain has come in the past few weeks. Now, that doesn’t mean that you should choose between putting $10,000 in Rio or $10,000 in a tiny offshore driller. That’s not a fair comparison.
What it does mean is that if you can make big returns like that from even one-in-five of your small-cap stocks, you can put less of your capital at risk because the potential returns are so much greater.
In other words, instead of putting $10,000 into Rio for your resources exposure, why not put $1,000 into each of three small or mid-cap resources stocks?
The worst that can happen is that each of those stocks goes bust. You’d be unlucky for that to happen. But even if it does, you’ve still only lost three grand.
I know, all of that goes against the conventional wisdom of blue-chip stocks being safer than small-cap stocks. On a like-for-like basis, it’s true. But if you change how you view small-cap stocks and how you use them in your portfolio, it’s actually possible to use small-caps to reduce your risk.
Kris Sayce+
Publisher, Money Morning
The post What if Stocks Just Aren’t Worth the Trouble? appeared first on Stock Market News, Finance and Investments | Money Morning Australia.