Opportunities in a horror bear market

This tumultuous sharemarket has been described as providing a huge fire sale, with prices of quality stock marked down by 40% to 60%. But investors should move with extreme caution when trying to take advantage of the buying opportunities. By MICHAEL LAUR

By Michael Laurence

Stocks for a bear market

This tumultuous sharemarket has been described as providing a huge fire sale, with prices of quality stock marked down by 40% to 60%. But investors should move with extreme caution when trying to take advantage of the buying opportunities.

Many share investors are in a dilemma about whether or not to buy into this sharemarket.

Should they take advantage of a highly-depressed market filled with what may be the biggest bargains of a lifetime – or at least a generation or two? Or should they wait to see if prices have much further to fall?

In favour of the buy-now argument, prices seem extremely tempting, given that the S&P/ASX200 Index is 47% down from its November high.

Craig James, chief equities economist for CommSec, says the price-earnings (p/e) multiple* of the All Ordinaries Index is “hovering near a 30-year low” while the index’s average dividend yield is near an 18-year high.

But in favour of the don’t-buy-yet argument, this is of course a breathtakingly volatile and treacherous market that appears not to have hit bottom. Global economic news seems to be getting worse day-by-day, and the extent of the volatility is illustrated by last week’s 7.4% downturn in the S&P/ASX200.

Should you be a buyer, or simply hold tight for a while?

Some leading market and investment specialists suggest that strictly long-term investors may consider highly cautious and highly selective buying, even though the market may well have further to fall – perhaps much further in a worse-case scenario.

Buyers should stick to top quality stocks, and buy progressively – rather than putting their entire store of cash on the line. And be prepared for much more volatility.

Prasad Patkar, portfolio manager with Platypus Asset Management, sums up the opportunities for investors: “Investors who buy good quality stocks and hold on to them through the volatility and for long enough should make a lot of money.”

Michael Heffernan, private client adviser and strategist for Austock Securities, says there is no question that a fire sale is taking place on the sharemarket, with some outstanding buys. “And you don’t have to go far outside the top 20 for buying opportunities,” he says. “But you have to be brave to put your money on the line.”

Heffernan says you may have to wait some years to be really rewarded for your bravery. “But you will look back and think how smart you were to buy at such great value.”

Here are six strategies to consider – along with some stock tips:

ONE. Acknowledge the value in the market:

Dominic McCormick, chief investment officer of Select Asset Management, agrees there are some standout opportunities in this market for definitely long-term share investors. “The sorts of valuations in this carnage no doubt provides opportunities for the long term. It has become more of a stock-picker’s market.”

Select Asset Management has been increasing its equity exposure in its diversified portfolios in the Australian and global markets. This has been done, in part, through rebalancing and, in part, by removing some hedging.

“One of my perspectives is that the best stock [buys at this time] are not necessarily on the Australian market,” McCormick says. “This bear market is providing a once-in-a-generation opportunity to buy some of the world’s great businesses at cheap valuations.

“Some investors can invest directly in overseas companies; others should use global equity managers that are not bench-market driven but focus on buying quality companies that are selling for cheaper-than-normal valuations that will grow over time.” McCormick emphasises that he is not talking about fund managers that concentrate on buying distressed companies.

And Prasad Patkar of Platypus Asset Management believes that the market has already priced in a severe global recession over the next 12 to 18 months. “A lot of gloom and doom has already been priced into these markets.”

TWO. Understand that the market may keep falling:

“There may be another leg down [before shares hit their lowest point in this bear market],” warns McCormick. “Who knows?”

Patkar says the economic news has to stop getting worse before sharemarkets can maintain a sustained rally. “Investors should be mindful of that.” Patkar points out that the sharemarket is forward-looking and will pickup before the economy begins to recover.

“No-one knows whether the markets are nearing a bottom,” he also warns.

Patkar believes that “we are still sliding” from an economic perspective. Inter-bank credit markets had improved a little but the credit outlook for consumers remained grim.

THREE. Make sure you are really investing for the long term:

McCormick, along with other investment specialists interviewed, stresses that investors should only buy in this market if they are there for the long term. But McCormick advises that would-be buyers really make sure they are long-term investors. It can be easy to fool yourself.

Investors should be satisfied that a setback such as the possible loss of a job or loss of confidence in the economy should not lead to the forced sale of shares bought now, McCormick says. He suspects that most of the possible forced sales from margin calls have already occurred, given the plummet in share prices.

And Patkar reinforces the point of being a long-term investor: “Never be in the position of being a forced seller. Plan for the worst,” he says, with an investment horizon of five, seven or even 10 years. However, Patkar emphasises that he expects the reward of investing now will come much sooner than in, say, 10 years.

FOUR. Be highly selective – and stay away from speculative stocks:

McCormick says the prices of quality large-cap stocks have been hit so hard in this bear market that investors do not have to “stray into smaller caps when looking for opportunities”.

And he adds: “Large companies are more liquid [than small-cap stocks] and they will be the first to recover. The better large caps will survive and prosper through this period.”

Patkar comments: “Investors need to be highly selective in my view, buying only the best-quality businesses that are in a position of unquestionable financial strength because they will need every bit of it in the next six to nine months as the challenges intensify.

“This is no time to be buying speculative stocks with weak balance sheets and implosion risk, because there is a good chance that they won’t be around when the recovery comes.”

FIVE. Average your way back into this volatile market – don’t rush:

Patkar says that although these markets may look very cheap “don’t go steaming back into them” by immediately investing all of your reserve capital. “Keep some of your power dry”, he suggests.

There was no rush for investors to pour capital into the market. “Investors have time on their hands,” he believes.

Patkar advocates an “averaging” strategy of progressively investing into the market. “Markets are doing extreme things,” he says. “What looks like a bargain now might look like a better bargain tomorrow.

“Volatility goes through the roof when markets are trying to bottom,” he says. But if the market suffered further big falls, an investor following an averaging strategy could simply buy more stock.

SIX. Identify possible standout buys:

Concentrate on quality companies that are well-placed to sustain the economic pressures and changing demands. Avoid companies of questionable quality.

Patkar names some of the standout buys in his view:

BHP Billiton. Patkar says the market has already priced the large diversified resources company for a severe recession. It has a “bullet-proof” balance sheet; strong management; and quality, long-life assets. “By and large, its [asset] portfolio is fantastic,” he says. “The key is that it will keep delivering cash profits, no matter whether commodity prices are up or down. BHP will deliver super profits when commodity prices are up.”

BHP Billiton closed at $25.10 yesterday (17 November 2008) – down from a 52-week high of $50.

Leighton Holdings. Patkar says the project development and contracting group has a strong balance sheet, assets and management. And Leighton is well-positioned – with the infrastructure and the skills – to take advantage of accelerating government spending on infrastructure in Australia and overseas.

Leighton Holdings closed at $23.80 yesterday – down from a 52-week high of $64.98.

WorleyParsons. Patkar believes the provider of specialist services to the energy and resource industries is well-positioned with its unique skills to provide for an “energy-hungry world”.

WorleyParsons closed at $13.23 yesterday – down from a 52-week high of $54.19.

SEEK, Computershare, ASX. “These are franchises that can hold earnings constant in the current difficult environment with strong cashflows and balance sheets,” Patkar says, adding that these companies have powerful market positions and solid managements.

“Unfortunately, they will be coming against cyclical headwinds over the next couple of years, but will [still] more than likely hold their earnings,” Patkar expects. “And if they can do that, these companies are well-positioned for the upside.”

SEEK, the online job site, closed at $3.30 yesterday – down from a 52-week high of $8.77. Computershare, the share registration company, closed at $6.96 yesterday – down from a 52-week high of $10.59. ASX closed at $30.85– down from a 52-week high of $61.

CSL, Cochlear, Sonic Healthcare. Patkar says these three medical companies have recession-resistant earnings, a high-level of government funding, and provide for an ageing population. And each has a strong balance sheet.

CSL closed at $36.70 yesterday – down from a 52-week high of $43.19. Cochlear closed at $56.84 yesterday – down from a 52-week high of $76.99. Sonic Healthcare closed at $12.95 – down from a 52-week high of $17.40.


* The price-earnings multiple is calculated by dividing a stock’s market price by its earnings per share. A stock with a lower multiple is considered cheaper.


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