The Shanghai Composite index ( China’s main stock market) rose above
3,000. That’s bullish for stocks around the world. I’ll show you why – and what I believe is the best way to play it, without risking your shirt.
China’s precipitous stock market growth is the source of a big debate in investment right now…
- Bulls see the 60% gain in the index and buy
- Bears see the recent pullback from those giddy heights and sell
So, which is it? Is the glass half-full or half-empty?
Why China’s rebound is bullish for worldwide stocks
I see both points of view. And for a time, I sided with the bears on this topic. But now I’ve changed my mind. Now I believe China’s recent stock market gyrations are a sign to buy, not sell.
I said myself in this column a couple of months ago that if the Shanghai Composite was to fall below 3,000 and stay down, it would be a body-blow for world markets. But that hasn’t happened. Chinese stocks have rebounded.
My fear was that when the leading light of world growth went down, the rest of the world would lose its way. However, when the market did fall, the global response was muted.
That is partly because the fall didn’t last. Investors in China don’t scare easy. They were supposed to sell but instead they bought. In the past two weeks, we have seen a nation of billions buy on the dip.
And this is exactly the issue all around the world as well. Investors are looking at stock market jitters as a buying opportunity.
Many private investors and fund managers alike have missed the rally that began on 6 March. Investors holding too much cash found themselves on the wrong side of the market move. So, it follows that if the FTSE in London or the S&P in the US were to fall investors would buy.
That’s why any coming correction will probably not cause the markets to fall further than 10%.
Old news is no news
As Nick Nelson, head of equity strategy at Swiss bank UBS recently told the FT:
“If we see a pull back, we would be ‘constructive’ on it.”
In practice, this means Nick’s clients, and many other investors besides, are prepped and ready to buy on the dips. I believe that this ‘constructive’ approach will, barring a major catastrophe, stem any major rout in the coming months.
You see, when the market falls for a well-known reason, no one really cares. Something as obvious a correction from expensive valuation will not drive a mass exodus from the stock market. Not on the scale that we saw last October.
To really give stock investors the willies, they need to be hit with something they don’t understand. Or, to use the correct City spiel, an “exogenous shock” or “black swan event.”
There are many such time-bombs that could materialise further down the road – interest rates, inflation, deflation, etc. But until then, the market will probably bounce back from any near-term market falls.
The obvious takeaway from this revelation is to simply continue to buy the market via an index tracking fund or an ETF. But that’s not something I’m going to recommend you do. I believe, more than ever before, it’s time to put your stock picking hat back on.
United we fall, divided we rise
At the worst point of the downturn we saw what happened when sentiment swings from greed into fear. Investors were sellers of nearly any type of investment and it sent all sectors of the market down together. The level of correlation between different stocks was at an all-time high of 55% according to figures from Barclays Wealth.
This level of fear obviously nullifies the power of picking good companies as investors aren’t looking to distinguish between winners and losers.
However, the herd mentality is ebbing away. Investors are starting to look at the world bottom-up rather than top-down and that means specific opportunities have a chance to shine.
So, what should you buy?
If you’re a risk-averse investor you will want to opt for safe high-yielding names like BP (ticker: BP.), Royal DutchShell (ticker: RDSA) and Vodafone (ticker: VOD). However, if you want to add a little spice to the sometimes pedestrian returns from these blue chips, I have been perfecting a strategy that you should check out.
It’s called a “stock replacement trade” and it involves buying “call options” instead of the underlying stock. The advantage of going for options instead of the three shares I’ve listed above, is that you could amplify the returns. Also, it can be a defensive way to invest.
If the market turns, your only loss will be the cost of the option – known as the premium. So you have a limited downside but with unlimited upside potential which could far enhance returns from the ordinary shares.
This is a guarded yet opportunistic way to take advantage of a bullish market that still has many problems to work through. In any case, it doesn’t look like China is going to be one of those problems.
Best wishes,
Theo Casey
For The Right Side
Editor’s note: Theo Casey is the editor and investment director of The Fleet Street Letter. Since recommending to his readers an oil-based stock replacement trade four weeks ago, the tip is already up 110%, compared to a gain of only 14.4% for the underlying share. Theo believes there is still further for this trade to go. To receive this recommendation alongside the rest of Theo’s tips, click here.
Please note: Past performance and forecasts are not reliable indicators of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Seek independent financial advice if necessary. Fleet Street Publications Ltd. 0207 633 3600.
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