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All Ords Report 04 May 2018

With the GFC well behind us, the Australian stock market having traded to a nine year high of 6,256 points in January 2018, and a strong rise in equities over recent weeks, more investors are considering borrowing to invest, but is this wise or a recipe for disaster?

For many investors, borrowing to buy stocks can be a double-edged sword. On the one hand, it gives you the power to dramatically increase your returns in a rising market, however, it can also produce the opposite, as your risk of loss is magnified if the market falls.

Let’s look at an example…

Margin lending is one way to gain greater exposure to the stock market. You’re able to borrow up to 70 per cent of the value of the stocks, which means you’re required to provide the other 30 per cent. So, if you have $30,000 in cash or shares you can create a portfolio worth $100,000. Best of all, you receive dividends based on $100,000, not $30,000.

So what’s the catch?

It’s important to consider both sides of the sword:

  1. If your portfolio rises by 10 per cent, you make $10,000 or around 33 per cent of your capital.
  2. If the market falls by the same amount, you lose $10,000 or 33 per cent of your capital.

This illustrates how both profits and losses are magnified by leverage and why you need to carefully consider whether leverage is for you. Also remember, you are required to pay interest on the loan amount.

Most of the demand for margin loans occurs just before a market top, and the biggest exit just before market bottoms. Why? The simple answer is, people without proper knowledge are swept up by market euphoria and fail to gain the required knowledge to manage the risks involved.

While the market is going up few worry about what lies ahead, but eventually conditions change and many are ill-prepared. To be better prepared, the best investment you’ll ever make is in your own education, so invest well.

Once you have the right knowledge, part of your recipe for success should be to never borrow more than you are willing to invest. If you have a dollar, you can borrow a dollar. For example, if you have $30,000 in cash or shares, only borrow $30,000 to lift your total portfolio value to $60,000. You may get rich slower, but it’s a lot safer and you won’t end up on the wrong side of the sword.

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What do we expect in the market?

The XAO may have begun a recovery, as buyers returned to purchase stocks at lower prices. The broader index has gained about half of what it lost when it fell from the high of 6,256 points in January 2018 to the low at 5,834 points in April. This week the All Ordinaries Index (XAO) traded to around 6,200 points, which is very important.

In a previous report, I mentioned that the downside on the XAO this year was less than that experienced on the US market, which indicates that our market is more defensive and therefore has the potential for a further rise.

Right now, the XAO is not in synch with movements on the Dow. The Australian market peaked on 10 January 2018, whereas the US market peaked on 26 January 2018. Also, the XAO has risen very strongly over the past few weeks from the low on 3 April 2018, whereas the US has been trading sideways since late March, having risen by around 1.1 per cent.

The rise in April through to early May exceeded my expectations in terms of its strength of the move. Analysis indicated that the XAO may rise for at least three weeks from the low in April, and if this occurred it would continue to rise to my short to medium term target at 6,440 points in the second half.

However, the XAO continued to accelerate higher this week, rising for a fourth consecutive week. This move reduces the risk of a fall below 5,850 points. That said, I would like to see the market pull back for a week or two towards the end of May or early June to test support before it continues to rise. A continuation of the current rise without testing the levels below it may indicate a more significant peak lies ahead.

What this indicates is that the sideways move on our market from January 2017 to October 2017 is acting as a very strong support zone. Instead of trading well into the zone the XAO dipped just below 5,850 points before reversing. Given the rise this week and my analysis, the market now has a very high probability of trading above the January 2018 high in the near term and achieving my next target at 6,440 points.

What I have been mindful of is that it is unusual to see the market fall less than 10 per cent (it fell by just 6.75 per cent) and for less than three months, when time analysis indicates that a two year low is due, that is, unless the market is about to turn quite bullish. Given the recent rise, the scales have tipped towards a bull market returning. Of course, we must continue to review as more data appears on the right of the chart.

Remember that the biggest mistake a trader can make is to assume they are right about the direction of the market, even if previous forecasts have been quite accurate.

With the market rising just before the Federal Budget is announced, this is a positive sign for the Government. Federal Treasurer, Scott Morrison is insisting that the Government will live within its means and achieve a surplus in 2020-21. However, I believe it is the promise of vast amounts of money being committed to road, rail, and building that will help drive the market higher.

Also, we’ve been producing the share market reports on our YouTube channel, so remember to watch them to stay up to date.

You can also subscribe to be notified when we upload the weekly recordings!

So welcome to the Wealth Within YouTube channel!

Dale Gillham is Chief Analyst at Wealth Within

All Ords Chart 04 May 2018

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