It is time to take some profits and build up portfolio cash with a view to buying back into the share market at lower prices in the next few months. This market is ripe for a pullback or possibly a correction, if COVID-19 data deteriorates.
I am not saying a savage share market fall is imminent or a repeat of the March sell-off is likely. Rather, that it is prudent to lighten equities exposure as the share market rises.
Too many retail investors become fully invested in equities when bull markets are in full flight. When the market tumbles, investors are left flatfooted amid a bear stampede.
They are caught in a vice: reluctant to sell stocks in a falling market to free up cash; and unable to buy back into the market at lower prices due to lack of cash. They become stuck on the sidelines as professional investors who lightened equity allocations, buy back in.
As they say, cash is most valuable when nobody has it.
Share market risks are rising. Chief among them is Victoria’s troubling second wave of COVID-19 and the possibility of New South Wales joining its southern neighbour with higher case rates.
Victoria’s six-week lockdown and the estimated $6 billion hit to the national economy is only part of the problem. Far bigger is the lockdown’s effect on business and consumer confidence.
Talk of Victoria possibly moving to stage-four restrictions (featuring widespread store closures) and a longer lockdown is especially unnerving for business – and has potential to slow Australia’s economic recovery.
How many businesses will invest if there is potential for further lockdowns each time COVID-19 cases spike? How many businesses will keep workers on as it becomes clear COVID-19 could drag on for years until a vaccine is found, which is far from certain?
I live in Victoria and the hit to business confidence is palpable. Some owners I know are considering shutting up for good, having to endure another brutal lockdown. The market seems oblivious to the damage that rolling lockdowns could have on business.
Better-than-expected health data in the first wave of COVID-19 partly justified the share market’s rally from late March. Australia flattened the COVID-19 curve faster than markets expected and the economic hit was less severe than first thought.
But COVID-19 data, here and overseas, has deteriorated, yet the share market has risen. Wild swings on Wall Street in the early part of this week suggest markets are adjusting to the likelihood that COVID-19 is more severe and longer lasting than first thought.
News of heavy provisioning for bad debts by US banks this week reinforces COVID-19’s potential to send more companies to the wall.
The Australian share market could be more volatile than usual in the next few weeks. The Federal Government’s economic statement and news on any extension of the JobKeeper and JobSeeker programs are key events. Then there is the reporting season in August.
The pullback I expect may have already started, judging by the falls in tech stocks here and overseas in the early part of this week. Either way, it is a good time to have more cash and a strategy to profit from, if the market heads lower in the next few weeks or months.
Here is a simple four-pronged strategy to consider:
Selling stocks and building up cash is one thing: knowing where to park that cash while waiting for a market pullback is another issue.
Putting your funds in at-call accounts means almost no return. Putting cash in a bank term means locking it away for months or years when liquidity is paramount.
The BetaShares High Interest Cash ETF (AAA) and iShares Core Cash ETF (BILL) are useful alternative for cash allocations. Cash ETFs pay slightly less than term deposits but have far higher liquidity. Investors can quickly sell their cash ETF on the ASX if they need that money back in their account to buy shares.
A reader asked during a recent Switzer Report webinar for my view on gold. I said the risks for gold were the upside and stand by that view. The United States Presidential election in November could put significant pressure on the Greenback, which is typically good for gold.
The gold uptrend has solid fundamentals, given the precious metal’s role as a safe-haven investment and store of value during periods of heightened market volatility.
The ETF Securities ETFS Physical Gold ETF (GOLD) is an efficient way to add to gold exposure to portfolios. It provides pure exposure to gold bullion, eliminating company risk. But as an unhedged ETF, there is currency risk.
If equity markets follow their usual pattern, GOLD should outperform during the next market pullback, rising when most other assets fall.
Chart 1: ETFS Physical Gold ETF
3. Profit from falling share market
Investors who expect the share market to pull back again during COVID-19 could use the BetaShares Australian Equities Bear Fund (BEAR). The inverse ETF is designed to rise when the S&P/ASX 200 Accumulation Index falls, enabling investors to profit from a bearish view.
A 1% fall in the index should equate to a 0.9-1.1% increase in BEAR, says BetaShares.
Bought and sold like a share, the ETF is a tool to ‘short’ the market for retail investors. Turnover in the ETF rose substantially during the market sell off in March.
More aggressive investors could use the geared version, Australian Equities Strong Bear Fund or the US Equities Strong Bear Hedge Fund – Currency Hedged. As with any geared product, leverage magnifies gains and losses. I prefer the ungeared version.
Care is need with inverse ETFs. Some overseas ones replicate their index using derivatives, adding counterparty risk. Also, inverse ETFs can have higher tracking-error risk if their performance diverges from their underlying index because of compounding. They are best used as a trading tool.
Chart 2: Betashares Australian Equities Bear Fund
4. When markets stabilise, buy global tech
Assuming markets play out as expected, investors will have made their portfolio more defensive through a higher gold allocation and added to their cash position. They might have a few extra profits from using ETFs to benefit from a falling market.
When the next sell off runs its course, the first sector to buy is information technology. Instead of picking a few tech stocks, buy the sector through an ETF and invest globally.
Readers will recall tech was my first idea when COVID-19 erupted in February and I maintained the tech theme for the next five weeks. Global tech stocks have rallied sharply since then.
Tech was the best-performing sector a year after the 2003 SARS crisis and has outperformed again during COVID-19. Increasingly, investors see big tech as much as a defensive play as a growth one, given the strength of the sector’s cash flow and quality of balance sheets.
The ETF Securities ETFS FANG+ ETF (FANG) is interesting new way to buy big tech. It is highly concentrated by ETF standards, holding just 10 stocks: Tesla, Amazon.com, Netflix, Alibaba Group, Apple, Nvidia Corp, Alphabet Inc, Baidu Inc, Twitter, and Facebook.
Essentially, the ETF provides exposure to the world’s largest US and Asian tech companies, which have mostly been go-to stocks for investors during the pandemic.
Expect key tech indices, such as the Nasdaq Composite Index, to fall sharply during any market sell off, given the extent of gains since March. Using the ETF Fang+ ETF to re-enter the global tech sector at lower prices in the next few weeks or months appeals.
Chart 3: ETFS FANG+ ETF
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 15 July 2020.