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The Australian sharemarket is heading towards the best and lowest-risk buying opportunity in 40 years. As such, investors should prepare themselves to enter the market again, and avoid the classic mistake of selling at the bottom and buying after the market rallies. DALE GILLHAM of Wealth Within reports.

Photo of Dale Gillham By Dale Gillham, Wealth Within

Any study of human psychology around investing always reveals how sentiment is heightened at the end of bull and bear markets. Too many investors tend to enter the market near the top and exit near the bottom. I find this interesting because these facts are widely known by investors and traders, and I have never conducted a seminar where those attending did not finish my sentence when I mentioned "amateurs buy at the top and sell at the…".

Obviously, educated investors do the opposite by buying near the bottom and selling near the top. The thing that bothers me is that even though everyone intellectually knows and can quote the statement, so few actually take the meaning of it to ensure they profit.

Does this make the majority of investors uneducated amateurs? Not necessarily, it just makes them human.

Facts don't lie and it is easy to find statistics on fund flows into and out of world markets. An Investment Company Institute report into net flows to mutual funds in the US between 1996 and 2010 showed that inflows (money going into the funds) were $US472 billion in 2006 and US$878 billion in 2007. In 2008, 2009 and 2010 net outflows were US$412 billion, US$149 billion and US$297 billion, respectively.

These statistics alone tell me the amateurs are selling or have sold, and as such the sharemarket bottom is near and the next bull run is about to start.

The choice investors need to make now is whether to follow the herd or take the real meaning from the above oft-quoted statement and invest more like an educated professional.

When nerves take over

Let's face it, markets don't crash at the top where everyone has made too much money to sell, and it is only after the market has experienced a big fall that the uneducated amateurs get nervous and offload shares. This is exactly what we saw in 2008 and 2009, while in the past couple of years the norm has been to continue the sell-off in a flight to cash.

Therefore, using our statement about amateurs investing at the wrong end of a run, this suggests the time to invest in cash has gone.

The economic clock below is pointing to a period of falling interest rates, and if you look from 5 o'clock to 7 o'clock the theme is consistent with what we are seeing around the world. Take the time to understand what is happening in the economy. Doing so will be a big reason why some will make money from the market while others won't, as making the right decision today will lead to a massive difference in retirement savings over the next decade.

The economic clock

The investment clock diagram
Source: Wealth Within

The saying "once bitten, twice shy" can best describe the way many investors have been feeling post- GFC and why funds have flowed to cash and bonds. However, I firmly believe that being part of the herd mentality and locking your money away right now is not the wise answer.

History has proved that the sharemarket provides the best returns of any asset class and my current analysis indicates the best time in 40 years to invest is just around the corner. Let me explain.

Chart 1 below is a yearly bar chart of the Australian sharemarket from 1875 to 1976.

All Ordinaries yearly bar chart from 1875 to 1976
Source: Wealth Within

There are three important areas on chart 1, the first being the low in 1892 when the market fell by around 40 per cent over five years; the second (grey shaded area mid-chart) being the crash of 1929 with the eventual low being in 1931 after falling by around 45 per cent; and the third being the four-year fall of around 60 per cent into 1974 (right-hand grey shading).

What can we learn from these falls?

  1. A 40 per cent or more fall in the sharemarket is not unusual.
  2. The market can, and has, fallen over periods of four and five years.
  3. There is roughly 40 years between these large falls; 39 years between 1892 and 1931, and 43 between 1931 and 1974.
  4. The market goes strongly bullish for many years after these falls.

Chart 2 below again shows the fall into 1974 (boxed area mid-chart), but we have added the projection of the next 40-year cycle low (boxed area right side of chart), with the midpoint being 2014.

Chart 2 All Ordinaries chart showing the fall into 1974 (boxed area mid-chart).

All Ordinaries chart showing the fall into 1974 (boxed area mid-chart)
Source: Wealth Within

Chart 3 below is a monthly chart from the low in 1974, on which I have placed some smaller cycles to more accurately determine the timing for the bottom of our market. I have placed the 105-month, or nine-year cycles (blue shaded area) which, from history, are very accurate in predicting future lows.

The current nine-year cycle, if not already in, is due any time until mid-2013. I have also placed on the chart the 18-year cycle (dashed area), and you will notice the low in 2009 fitted perfectly into the timeframe of this cycle, and is also inside the area for the 40-year low.

This could imply that we have had the 40-year low and I am not ruling that out. However, how the market has unfolded since then leads me to think this is less likely. As space does not permit full explanation of the cycles, my thoughts on the market are simplified, but I have recorded an online seminar in which I go into much more detail.

Chart 3 All Ordinaries monthly chart from the low in 1974 (boxed shaded area) 

All Ordinaries monthly chart from the low in 1974 (boxed shaded area)
Source: Wealth Within

The basis of what I have written here is not new, yet very few people ever really put it all together. So what should be your strategy?

Since the GFC, more investors are giving vital factors a second thought, the first being to question conventional wisdom about how to profit from the markets. Second, they are realising the critical importance of market timing.

Two critical traits cause investors and traders to constantly make mistakes:

  1. Poor timing
  2. Lack of patience.

We have already handled point 1, and suffice to say it comes as a direct result of point 2, which I see as the trigger alerting me to the possible change in market direction. That is, when everyone is sick and tired of the market and the masses are leaving for cash, I can assume that pretty much anyone who was going to sell has sold. With no one left to sell, the market must rise.

From the low in 2009 there were two ways the market was likely to unfold. The best-case scenario said the long-term low had occurred and the market was likely to recover to around 5200 to 6000 points before continuing to rise towards the 2007 high. The second and worst-case scenario was the market would move up to around 5200 points and then continue down to take out the 2009 low so as to complete the 40-year cycle in a similar fashion as seen in the early 1970s.

Prepare to re-enter the market

To date, the way the market is unfolding is more aligned to my second and worst-case scenario, where our market could at least pull back to test the 2009 low, if not fall below it.

That said, while the market continues to show support at around 4100 to 4200 points this view is inconclusive. So if I am correct, we are heading towards the best and lowest-risk buying opportunity in 40 years, regardless of where the market heads from here. As such, I would suggest investors take some time to prepare themselves to enter the market again.

The challenge is that instead of embracing the opportunity, typically investors will wait until years into the bull market before moving away from secure cash-type investments, and in doing so miss out on the best and lowest-risk part of the bull run.

Right now, investors have to weigh up two options:

  1. If the intention is to invest for the long term, you can invest now in good-quality blue chips for five years or more with less risk, as long as you are patient. So even if the market falls from its current levels over the next six months, you will reap the rewards over time, because I am confident the sharemarket will significantly outperform any other market over the next five years.
  2. You can sit back and wait for the possible worst-case scenario. The only thing you are risking is that the market rises and you miss out on purchasing some good shares at cheap prices. However, it is far more profitable to miss out on 10 per cent than to lose 10 per cent.

With this in mind, and with what you know now, would you have made different decisions during the GFC? More importantly, what decisions will you make in the future and will you follow along the lines of what amateurs do? Or will you make educated decisions?

I think Warren Buffett said it best: "Buy in doom and sell in boom".

About the author

Dale Gillham is author of How to Beat the Managed Funds by 20%, and is Director/Chief Analyst of Wealth Within.

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