Counter-cyclical traders bask in year results

By Peter V O'Brien

Friday 16th July 2004

The bears of last July who decided a rally on world sharemarkets over the preceding six months was an aberration in a medium to long-term downward trend were proved wrong in the ensuing 12 months.

They lost out to bulls who saw the rally as the start of a sustainable recovery from earlier depressed levels, subject to normal blips.

The table shows what happened to market indices in New Zealand, Australia, US, UK and Japan over the past year and since the end of 2003. All indices recorded solid improvements in the 12 months ended last Friday, although the US benchmarks have dipped slightly since December.

Counter-cyclical traders who bought stocks in March and April 2003 when prices were depressed (Japan was at a 20-year low) would be enjoying subsequent gains, the extent of the enjoyment depending on whether they still held the investments or if and when they took profit.

Comments in the National Business Review about counter-cyclical investing, including those made last July, have noted that the technique required nerve and some arrogance, whether people were operating as traders or for longer periods.

Arrogance arose from setting one's judgment against the majority in deciding to buy when everyone else sold and selling when they bought.

Selling when everyone else bought had to be tempered with any eye to timing, as did the buying side of the counter-cyclical approach. That meant assessing when a market was over-bought (or oversold if you preferred to buy) and "leaving something for the other guy."

Selling or buying immediately the market turned would be an unsophisticated philosophy, because the investor would show the same addiction to short-term thinking as those who caused the turn.

Counter-cyclical investing obviously goes beyond buying or selling all the component stocks of an index, although futures dealers trade sharemarket index contracts.

The counter-cyclical technique has particular application to individual stocks because the conglomerate nature of an index can smooth movements in the component share prices.

Its desirability and the question of timing can be examined in relation to the share price performance of specific New Zealand companies since the end of 2002.

The stocks selected were retailers Briscoe Group and The Warehouse Group, electronic vending equipment specialist VTL Group, dental software provider Software of Excellence International and electric motor manufacturer Wellington Drive Technologies. (There is no suggestion that the shares in any or all of those companies should have been bought or sold at any given time.)

The selection provided a range of types of price movements.

Briscoe's share price declined 52.4% between the end of 2002 and last Friday, going from $2.75 to $1.31, and The Warehouse fell 44% from $7.32 to $4.10. Each company's price had ups as well as downs over the period when swift operators could have gained but the overall trends were down.

Both companies had substantial business operations, so there was no blue-sky element in their share prices.

The Warehouse's profitability suffered from an expensive entry into Australia and Briscoe acknowledged it had become involved in an enervating price war with competitors.

Managing director Rod Duke told this year's annual meeting the company had recognised it "must wean ourselves off our deep-discount strategy this approach is unsustainable going forward."

Briscoe and The Warehouse are reorganising their operations to increase profitability. Their share prices would improve, assuming they succeeded in that goal. The trick (and the investment risk) is one of timing, but companies in such situations could prove the validity of counter-cyclical investment, although it would have paid to be without Briscoe and The Warehouse for most of the past 18 months.

VTL's shares were $1.70 in December 2002 and 99c on July 9, a fall of 41.8%. The price hit 45c in 2003, so a counter-cyclical investor could be more than doubled an outlay over the past 12 months, given exquisite timing ability.

Software of Excellence has made considerable progress in market penetration of its product overseas, but has yet to reach "critical mass" in revenue and resulting profitability.

The company's share prices since the end of 2002 was a good example of how counter-cyclical trading could be profitable.

It closed 2002 at $1.28, improved 56.2% to $2.00 in 2003 and came back 25% to $1.50 last week. A buyer at the end of 2002 who kept the stock still had a profit but could have won twice through well-timed trading.

Wellington Drive was a similar situation, going from 38c at the end of 2002 to 72c at December 31, 2003 (before adjusting for a 1:8 issue in September that year) and retreating to 53c last week.

Those movements offered good gains for proponents of counter-cyclical investing.

Comments from our readers

No comments yet