Did the Stock Market Overreact Last Week?

It is common for investors to blindly follow the herd, which often means they are more focused on receiving income rather than capital growth they could gain from buying stocks. However, smart investors know that investing is not just about income, it’s about the total return because chasing 7 per cent for income while the stock is falling 20 per cent or more simply doesn’t make sense.

What are you giving up by only chasing dividends?

Many times, investors give up much more in capital than they gain in income and Telstra is a perfect example of this. It fell 72 per cent over nearly 12 years between 1999 and 2010 and after rising over 4 years, it fell 61 per cent between 2015 and 2018. During this time, investors held the stock for the dividend income, yet many long term investors would be lucky if they were in profit, especially when you factor in inflation.

Investors are often encouraged to hold real estate stocks and REITS long term, so as to receive dividends which has not been a wise strategy this year. A study of 45 of these stocks shows that 40 have averaged a loss of 20 per cent since 1 January. The average dividend yield on property stocks is just over 4 per cent, so investors are really going backwards by holding these stocks.

With the current challenges around commercial property caused by COVID and employees preferring to work from home more, I suspect we may not have seen an end to the downfall in real estate stocks and REITS. While I am not suggesting this will continue over the long term like Telstra and fall for ten or more years, investors need to be mindful they are investing to make a profit.

Regardless of the stock prices direction, we also need to remember that a company can reduce or suspend dividends at any time, which they did during the COVID meltdown. You also need to remember that the more the price of a stock falls the higher the dividend yield, which is often used to tempt investors into buying and holding these stocks in an attempt to suspend the falling share price.

Given this, it’s wise to understand that a high dividend yield may not always be the opportunity you think because you could just be catching a falling knife. First and foremost, investors should focus on stocks that will rise in value before considering any dividend yield.

What were the best and worst performing sectors last week?

The best performing sectors included Energy down 0.46 per cent followed by Utilities down 0.47 per cent and Financials down 0.54 per cent. The worst performing sectors included Healthcare down 4.06 per cent followed by Industrials down 3.60 per cent and Consumer Staples down 3.09 per cent.

The best performers in the S&P/ASX top 100 stocks included the Star Entertainment Group up 9.02 per cent followed by AMP up 7.08 per cent and Computershare up 5.65 per cent. The worst performing stocks included Atlas Arteria down 17.42 per cent followed by Lynas Rare Earths down 11.66 per cent and Evolution Mining down 10.96 per cent

What's next for the Australian stock market?

What an interesting week it was for the All Ordinaries Index early last week as it continued to rise from the previous week before falling 2.5 per cent on Wednesday on news that the Dow Jones had fallen nearly 4 per cent the previous night. When events like this occur, it is interesting how investors make knee-jerk reactions while the big end of town profits on these emotions.

Right now, it is still possible that the market has not stopped falling, which is why I have recommended investors wait for confirmation before buying. That said, the events of last week have not changed my opinion that the market will turn bullish because while it closed lower, it was technically an up week as price traded higher. It is possible that the dip last week was just an overreaction to the Dow falling and while the Dow Jones is weak and may fall further, it does not mean our market will fall with it.

If the All Ordinaries Index has bottomed, as I still suspect it has, then we will see it move up over the next month or so to erode most of the losses experienced this year. If the market does move down this week, I believe it will be short lived. For now, it is still wise to sit tight until we can confirm the direction of the market.

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 bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online.