As your columnist writes a sea of red is hitting his screen. A clue is that it isn’t a Santa virus.
Many market pundits have been singing that there will be a Santa rally because of various reasons, such as hopes of a successful resolution of the European sovereign debt woes, or that the Tea Party has shouted itself into obscurity (remember that it was more than partly responsible for the debt ceiling stand-off in the US last July).
What we’re seeing today is the market in free fall. The benchmark ASX 200 Index is down 2.3 per cent, the ASX All Ordinaries is 2.4 per cent lower; while the ASX Small Ordinaries is falling the hardest - down 3.5 per cent.
What’s happening can be at least partly explained due to end of year shenanigans.
At the year-end, fund managers have to account on quarterly basis for their holdings. In many cases they won’t want to explain to their various trustees why they have a holding, so they may sell more aggressively than they would otherwise.
This doesn’t necessarily have a poor impact on a normal market. When things are humming along, a bit of switching goes unnoticed.
But sentiment is at its worst levels since the depths of the financial crisis in 2008. In times like this, fund managers bail out of stocks they consider to be the most risky. In many cases these are the little ones. Going into Christmas, a fund manager wants to drink his sherry in the knowledge that he will come back to a company that won’t be 20 per cent below its current price when he gets back to the office.
The impact on small companies is highest. These companies are not traded much and are vulnerable when volume from the offer side hits the bid.
But right now is also an opportunity to profit. You have to play it very carefully, however. Many use the over-used falling knife metaphor. This basically means you can buy something that looks cheap today, but will kill your portfolio returns tomorrow.
But this is not always the case. It’s certainly not the case when the market as a whole gets very very cheap. At current levels, Under the Radar Report’s Portfolio Manager says that we are close to “entering the kill zone”, referring to a situation where stocks get so cheap that they have to be bought.
In our model portfolio, he has been very careful not to step up and buy too quickly, just because we see value.
A situation where the market reaches this situation and is so over-sold to this extent occurs very rarely. At the other end of the spectrum, stocks as a whole can get so expensive that you wouldn’t touch any of them.
Most of the time stocks trade at a discount or premium to a fair value that an investor might attribute to the company. But this value might never be realised.
In the two extreme cases, however, they should move towards fair value sooner, rather than later. In the case of the oversold market, this must be premised with the fact that not all of them may survive (which is what is being factored in by the market in the doomsday scenario).
In the case of the vast majority of companies, they will survive. And if you show more courage than some fund managers are showing, you should reap the rewards.