We awoke to Westpac Banking Corporation's (ASX: WBC) senior economist James Shugg's somewhat pessimistic view of overnight events in Europe…
"Look, I'm really worried. I think November 9th is going to be remembered as the day Italy dragged Europe into a very deep recession and the world couldn't escape from it…this is serious stuff."
Happy Thursday to you too James.
Fear is back, with a vengeance
Wall Street crashed over 3.5 per cent. The VIX, otherwise known as the fear index, soared over 30 per cent. The Aussie dollar slumped back towards parity. Even gold, the so-called safe haven, fell, although admittedly its falls were relatively modest.
If you're a glass half-empty person, it's a red-letter day for you.
As well as James Shugg, we had International Monetary Fund Managing Director Christine Lagarde warning of the risk of a "lost decade" for the global economy unless nations act together to counter threats to growth.
"It's just like a scary movie as it never ends," said Keith Wirtz on Bloomberg. "The overarching problem is that most of the economies in Europe can't sustain the size of their governments. We're going to have this headache for a long time to come."
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Throwing the baby out
In such an environment, investors can forget all about company fundamentals. The baby gets thrown out with the bathwater.
As well as the usual suspects, like Fortescue Metals Group (ASX: FMG) and Iluka Resources Limited (ASX: ILU), other commodity stocks are taking it on the chin, with Rio Tinto Limited (ASX: RIO), Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL) all down over 3 per cent in morning trade.
It's at moments like these, when investors all around us are in danger of losing their heads, that we throw things over to The Motley Fool's Investment Analyst Dean Morel.
In almost 25 years of active investing, he's seen this sort of stuff before. Many times before. Dean's cool, calm and collected thinking is exactly what's missing from much of the mainstream media. 'Staying calm' doesn't sell many newspapers.
Over to Dean, who naturally enough, sees opportunities in such a chaotic market…
Volatility is our friend
The most important idea to remember, or better yet believe and embrace, is that a volatile market is our friend. As lifelong investors it is important to love volatility and to seize the opportunities it throws our way.
Sharemarkets are for the most part rational. That means equities are fairly priced most of the time and it is difficult to find bargains — though that never stops us from digging deep and trying our hardest to find those hidden gems.
When bearish volatility, caused by emotions and a lack of reason, leads humans to herd, sharemarkets become irrational and oversold. That irrationality allows investors who are able to control their emotions and act in a calm, balanced manner, to take advantage of the many opportunities the market throws up.
In short, volatile markets make our job as investors easier as many more opportunities are thrown our way. The challenge is to control our emotions when others around us are flailing and responding manically to the market's noise.
How to check your emotions at the door
A reader recently asked us what the definition of long-term was. Is it 3-5 years, 5-7 years or longer? I see no point in arbitrarily assigning a specific number of years to the phrase long-term. To me long term means the rest of my life. I will be an investor for the rest of my life, and I invest accordingly.
I realise that may not be very helpful to everyone, so perhaps think about long-term in the following way. Your starting point for long-term should be the number of years until your retirement. For most people that is what they should be investing for and that should be their long- term. Any money that you require in the next 3-5 years should be in cash or equivalents.
Once you start thinking about long term in that mindset you'll hopefully start to cheer falling markets. As I've said before, falling markets caused by irrational investors lets us buy Louis Roederer Cristal – très yummy expensive champagne – for the price of cheap sparkling wine.
Thinking about your investing and the long-term in this way should let you check your emotions at the door and allow you to buy shares when volatility throws opportunities your way.
Yeah yeah, but how about an actionable plan?
OK. One of the easiest ways to remove your emotions is to invest regularly. By investing regularly, say every month, you'll be less worried about what the market is doing.
So think very long-term, invest regularly and try to be opportunistic when fear pervades the market.
There is no need to make big decisions. You don't need to be fully invested in, or totally out of the market. Gradually building positions in the best companies while maintaining a cash cushion will make investing easier and less stressful.
All of this should be even easier for newer investors. When you're young and have a limited amount of money invested, the biggest contributor to your long term wealth and financial independence is you, not the sharemarket. The amount you save and invest every year will most likely dwarf your sharemarket returns. So save hard and invest in yourself as well as in equities.
Where should I look for bargains?
Right now two sectors that appear attractive are asset managers and retail.
Within retail, I recommend looking beyond department stores like David Jones Ltd. (ASX: DJS) and Myer Holdings Limited (ASX: MYR), and big box retailers like Harvey Norman Holdings Ltd. (ASX: HVN). They appear like value traps to me.
When digging through sectors for bargains, it's useful to have a yardstick to compare companies against. For asset managers, I compare companies to Hunter Hall International Ltd. (ASX: HHL) and Platinum Asset Management (ASX: PTM). In the retail sector OrotonGroup Ltd. (ASX: ORL) and JB Hi‑Fi Limited (ASX:JBH) are my yardsticks.
I'm not suggesting you buy those specific shares today, but they are on my radar, as are other asset managers and retailers. Our forthcoming subscription-only newsletter will elaborate further over the coming months. As ever, we'll keep you posted.
Let's get rational, rational. I wanna get rational.
I hope you understand my point of view.
Sorry to have gone all Olive Newton-John on you. I don't know what came over me!
As we're talking about rational markets, now may be a good time to explain why I like, and am long, Telstra Corporation Limited (ASX: TLS).
Ever since the Gospel of Matthew and no doubt before, humans have understood that investment returns are a reward for talking risk. Unfortunately modern finance mistakenly made volatility synonymous for risk.
Risk is better defined as the probability of a permanent loss of capital, or as uncertainty. But how ever risk is defined, Telstra has an attractive risk to reward profile.
If fear wins the day and global stock markets unravel, Telstra will very likely outperform the broader market. That is, its price will go down less. Telstra is also less volatile than the market. At the same time Telstra offers one of the highest yields in the market and that yield is close to certain for the next two years.
The best of both worlds
So Telstra offers a considerably better direct return to shareholders than the broader market, and has less risk to the downside. Investors are being overcompensated for the risk they are taking. Theoretically impossible, but there it is!
The main risk to Telstra is that if the world sorts out its current problems and sharemarkets take off, Telstra's share price will under-perform a rising market. But as Telstra has a gross yield of almost 13%, I can certainly live with underperforming a rising market.
If you are looking for another stock you can bet on now, readers need look no further than The Motley Fool's Top Stock For 2012. Click here now to request this special report, while it's still free and available.
Dean Morel has positions in Telstra and Hunter Hall. Bruce Jackson has an interest in Telstra, Westpac, ANZ and NAB.
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