Last week while holidaying in New Zealand, I was reminded that investors don’t actually pay capital gains on their investments. However, the same cannot be said for Australia. In my opinion I believe we pay far too much tax on our investments especially when it comes to property where stamp duty and land taxes makes it almost impossible for an investor to turn a profit for several years.

In the share market people use capital gains tax as an excuse for poor portfolio management because they are concerned that if they sell they will have to pay too much tax. But let’s face it, if you are paying tax it means you have made money, which is the whole point of investing. Holding onto a stock simply because you want to avoid paying tax could cost you a lot of money and lost opportunity particularly if the share falls in value because you are losing profits. Indeed, the amount of capital gains tax you will pay could be much less than the amount you lose. A rule I always use, is to never make an investment decision solely based on tax.      

So what can we expect in the market?

In previous reports I have mentioned my concern that the market is currently travelling faster in price than we have seen in the last 25 years and it is doing so on lower volumes. Surprisingly, nothing has changed in the last week as the record pace of the current bull-run has continued to push the market to new all time highs. I do not believe this pace is sustainable and I still expect the market to fall by a few per cent over one or possibly two weeks in the very near future to bring some normality to our market. This is supported by the fact that over the next three weeks we are entering a very unpredictable time period on our market with natural support and resistance levels likely to be unreliable. Given this, I would urge investors to exercise caution over this period.  

As we all know the market runs on fear and greed, and there has certainly been a case of rampant fear over the last few weeks resulting in the market falling heavily.

I believe the underlying cause of the market volatility is something that I have been talking about for a long time and is the over exposure to leveraged positions. This is resulting in individuals and institutions selling on mass right now in order to protect capital.

In recent years, leveraging has increased ten fold which has been fuelled by the greed for higher returns. However, this over exposure to leveraging also increases the risk associated with investing and in turn the fear of losing. If we then consider the use of technology and the ease with which we can access information, you can see how this would further fuel fear in the market place.

While the market was always going to fall into its normal cycle, it is obvious that the recent pull back has been amplified by the use of both leveraging and technology. Opportunities like this, however, pay testament to Aesop’s Fable about the tortoise and the hare given that now is the time for the tortoise to look for opportunities while the hare is distracted.

So what’s happening on the market?

I have heard the term ‘market crash’ being used this week by different market commentators, however, let me say that our market is definitely not crashing. As you know I have been saying for the last few months that the market needed to pull back to below 6000 points and while this has taken longer than anticipated, I can assure you that what has happened over the last two weeks is quite normal.

The unsettling news is that the pull back may not yet be over. On Wednesday 2 August, the All Ordinaries Index fell to 5952 points, confirming my first price target for the fall. From here I believe the market will rise for at least 1 to 2 weeks as it rebounds before possibly falling away again.

For the market to prove it is bullish, it needs to rise for at least 4 to 6 weeks - if it fails to rise for more than 2 weeks, we can expect another fall to occur with price moving down to below 5800 points and possibly to as low as 5600 points. If this does eventuate, the total fall will equate to around 12% from the all time high of 6469.20 points which is on par with a normal market pull back.

In recent months, there have been an increasing number of clients asking whether they should diversify their portfolio into overseas equities based on the fact they are receiving advice from their financial planner that they overweighted to the Australian market. This is an interesting debate and one which I always question, particularly in regards to the motivations of the financial planner giving the advice.

Diversification, in its true sense, means to diversify into other asset classes (fixed interest, property) that are unrelated to the asset class in which you are investing in order to reduce the risk of your investment portfolio and increase returns. However, the argument that diversification into overseas equities can lower risk without sacrificing returns is a myth perpetuated by many in the financial services industry. If we just look at the Australian share market this year, it has risen 14.01% in comparison to the Dow, which has only risen 9.38%. That’s a whopping 49.25% difference. And if we compare each market over the last 4 years, the All Ordinaries has outperformed the Dow year in, year out. In my opinion, investing in the same assets offshore not only di-worsify’s your portfolio but condemns you to mediocre returns.

So what is happening on the market?

Since my last report the market has continued to rise to test the last all time high of 6435.70 points achieved on 4 June. I also stated that I expected some weakness to occur in the market earlier this week and for the All Ordinaries fall away. And while the market traded up until Wednesday of this week to within 9 points of the all time high, it is now showing signs of weakness as it fell away slightly yesterday and is falling today.

I believe the weakness in the market will continue over the next few weeks, which will see the All Ordinaries fall away into its yearly low, although that said we do not have confirmation of this yet. Given this, there is still a low probability that the market will move up to break above its all time high but it will need to break strongly through the all time high to indicate that the market is still bullish. If I am correct and the market does fall away, I believe it will fall into mid July and below 6000 points.

A research paper recently released by Inalytics indicates that most fund managers fall into the same trap as individual investors when it comes to shares by selling winning investments and holding on to underperformers. It seems that the majority of fund managers are optimists, spending more time buying stocks rather than managing their positions to sell at the right time, which explains why the majority of fund managers fail to outperform the index. It is common for investors to sell winning stocks because they fear taking additional risks with stocks in which they have already made money, which also appears to ring true for fund managers. Given this, you have to ask why investors would pay to invest their money with these so called’ experts?  In my opinion, unless the fund managers learn how to time the market by selling losers to hang onto winners, they will continually under perform the index. 

So what is happening on the market?  

After reaching a new all time high of 6435.05 on the 4^th of June the market fell away 3.59% over the next 6 days into a low of 6200.10 on Wednesday this week. Yesterday the market rebounded strongly rising nearly 80 points and it has continued to trade up today. In my last report I indicated that with the current indecision in the market, anything was possible and that the All Ordinaries could trade above its recent highs. The market is obviously rising right now to test the all time high, which is normal as markets will generally test major highs and lows before deciding on a direction. What happens over the next few days will confirm whether the pull back I have expecting is unfolding or whether the market is still bullish.     Given that I believe the market is moving into its yearly low, I suspect that we will see some weakness in the market either today or Monday which will see the All Ordinaries fall away. If the market continues to move up over the next week it will need to break strongly above the all time high of 6435.05 for my opinion to change. If I am correct and the market falls away, I expect it will fall into mid July and below 6000 points.      

Australian Capital Reserve (ACR) is yet another property group to collapse within the last year. ACR targeted small investors promising above average returns to raise money via unsecured deposit notes to fund property developments. While on the surface it appears as though this is a good investment, there are at least two issues of concern; firstly, the fact that the investment was unsecured and secondly, the investment is only as good as the company backing it. If funds had been invested in well established and well run companies like Westfield or Lend Lease, then the investment could have been considered low risk, given their long track record in property. While the lure of higher than average returns is attractive, investors should have been warned that ACR was a high risk investment given the money was unsecured. That said higher than average returns doesn’t always mean high risk; it just means the investor needs to understand the investment vehicle and who they are dealing with, what is securing the investment and how liquid it is in case they need to exit.     

So what is happening on the market?

Last week I stated that it was still too early to confirm that the market was falling into its yearly cycle low as it had traded sideways over the previous three weeks. And this indecision has continued in the last week resulting in the All Ordinaries trading roughly within a 2% range throughout May. Given that the market has continued to trade sideways following the rise of around 10% from early March to mid April indicates that the current bull market is definitely slowing.

Although there haven’t been many instances where the market has traded sideways in the past few years, it is a very normal occurrence and, once disequilibrium occurs between the buyers and sellers the market will find its direction. As you know I have been expecting the market to move down into its yearly low, therefore I believe the sellers will take hold and the All ordinaries will fall away. That said it could still rise up strongly to break above the all time high of 6390.3 set on 22 May, although I believe the probability of this occurring in the near future is low. Right now, I think investors should take a wait and see attitude until the market settles on a direction.