Has the Stock Market Bottomed Out Yet?

When the market falls heavily, like it has over the past few weeks, it is very common for investors to want to get into stocks for two reasons. The first is their emotions, as many are controlled by the fear of missing out although in the current market conditions, it would be wise to be patient. The second reason investors want to buy in is because they believe stocks are cheap given how far they have fallen. 

What is a cheap stock?

Cheap implies that you will get a bargain, which maybe the case when you go to the supermarket, but it is not the best mindset or strategy to adopt when investing in the stock market, as it can be an expensive mistake.

Many people buy stocks because they perceive them as cheap, but exactly what do they mean by cheap? Is a stock that is falling in value cheap? Maybe, provided it doesn’t continue to fall once you purchase it. Is a stock trading under $5 cheap? Maybe but you have to ask, cheap in comparison to what? Is a stock that is trading under $1 good value? Possibly, although many of these stocks are referred to as “penny dreadful” stocks and for good reason.

While it is easy to compare two items at the supermarket to determine whether you are getting a bargain, you cannot do the same when it comes to comparing stocks, as price alone does not imply that it is cheap or expensive. A stock is only cheap or expensive in comparison to the real value of the asset, not just the price of the share at any one point in time.

I have lost count of the number of people who have told me they invested in a stock because it was cheap. When I ask why, they tell me they can buy more shares in a stock that is trading at $0.50 than they could buy if a stock was trading at $20. But it’s important to understand that the amount of shares you own is irrelevant to your potential profit. Let me explain.

If I have $1,000 to invest, I can purchase 2000 shares at $0.50 or 50 shares at $20. If the shares rise by 10 per cent, do I make more money on the $1,000 invested in the $0.50 shares compared to the $20 shares. The result is exactly the same, although it is highly likely that a $20 blue chip stock has more potential to rise by 10 per cent than the $0.50 stock, and is far less likely to fall heavily in price

While there is always temptation to buy shares that have fallen heavily, I would caution you against doing this because in my experience, when investors buy cheap stocks trying to get a “good buy”, they usually end up saying “goodbye” to their money. So now is not the time to be buying and contrary to what you may be thinking, there will be plenty of time to profit once the market confirms it has stopped falling.

What were the best and worst performing sectors last week?

With so much going on over the past few weeks, it has felt like time has moved much slower than normal. I know I have said in the past that a week can be a long time in the stock market given that last week everything was falling heavily, yet last week it was the opposite.

Industrials lead the way up over 9 per cent, followed by Information Technology up over 8 per cent and Materials rose 4 per cent for the week. Four sectors ended the week in the red with Consumer Staples down over 5 per cent, Financials was down over 3 per cent, and Communication Services and Utilities were both down over 1 per cent.

Looking at the ASX top 100 stocks, we would normally be quite happy to see stocks up a few per cent on the previous week yet as of writing, around 40 per cent of the top 100 stocks rose last week, and 13 per cent rose more than 10 per cent for the week. Surprisingly, Qantas led the charge up over 31 per cent, while Sydney Airport was up over 24 per cent and Star Entertainment Group rose over 23 per cent.

The worst performers for the week were Vicinity Centres down nearly 15 per cent, Bank of Queensland, which was down over 14 per cent, Lend Lease down over 12 per cent and JB Hifi down nearly 12 per cent.

What's next for the Australian share market?

On Monday the All Ordinaries Index fell to 4429.12 points making the current crash 22 days long and the fall 39 per cent from the high on 20 February. After falling on Monday, the market rose strongly the next three days before falling back on Friday to end the week just 24 points higher than the previous weeks close.

Investors are constantly asking if the market has bottomed out yet, as though someone is going to ring a bell to tell them the bottom is in and it’s now time to buy. Remember, it is normal for the market to bounce and retest prior highs and last week I mentioned that we should see this occur any day now and for this to last over one or more weeks.

It is foolhardy to jump into a volatile market that has only risen for a few days after falling so heavily; in fact, is it very dangerous. As I said previously, right now, investors need to be patient as there will be plenty of time to buy into good stocks. What is likely to unfold is that we will see a short rise over the next one to four weeks before the market falls away to test the prior low. While nothing is certain, it is dangerous over the next month to attempt to bottom pick perceived cheap stocks trying to grab a bargain.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.