How to pick next year's sharemarket winners

The great thing about the stock market at the end of the financial year is that you can look back and see everything you should have done. Hindsight is a wonderful thing. Every year it tells you there were a handful of things you needed to know over the past 12 months, things that cut through the economic debate, the financial theory, the blah blah blah of media noise and all the other distractions and complications the industry relentlessly throws at us.

Bank shares have taken a hammering, partly because of  the royal commission.

Bank shares have taken a hammering, partly because of the royal commission.

Instead, there were a few key pieces of knowledge in the past year that could have transformed our lives. A few themes and events that, had we stopped for a moment and taken the time to consider, we just might have guessed.

Last financial year, for instance, all you had to know was to be long the resources sector (+35.8 per cent) and short the bank sector (-6.74 per cent) and avoid Telstra (-38.5 per cent) and AMP (-31.4 per cent).

The headlines will tell you the ASX was up 8.27 per cent over the year or 13.7 per cent including dividends. But the more interesting and tantalising statistic is that last financial year the top-20 performing stocks in the ASX 200 averaged a rise of 109 per cent while the bottom 20 stocks averaged a fall of 22 per cent.

We all focus on what "the market" does, but the individual stock performances tell you the index is, for the average stockpicker running a self-managed super fund, pretty much irrelevant, because picking the right 20 stocks would have doubled your money and avoiding the wrong 20 stocks would have saved you 22 per cent. And the individual stock basis in the ASX 200 performances ranged from a 235 per cent gain to a 38.5 per cent loss (Telstra). There is more than enough opportunity in the top 200 stocks to keep us heartily entertained, let alone in the top 500 stocks in the All Ordinaries or in all 2274 listed Australian stocks, and the market itself is a media talking point, not an investment reality.

So, what will be the 20 best and worst stocks in the coming 12 months? I’ll tell you. The stocks that do something unexpected.

Over any period, the stocks that move are not those that do what was expected but those that do the unexpected, the stocks that surprise. For instance, if BHP hits its consensus forecasts the share price won’t move. Share prices move on new information and, by definition, unexpected information, not on expectations being hit or on forecasts being fulfilled. To move the share price, forecasts have to be beaten or missed, because there is no money to be made out of consensus forecasts that are in the share prices already. The holy grail for the investor is to correctly identify inaccuracies. You have to guess what the market has wrong, because that’s where the money is.

So, what will be the 20 best and worst stocks in the coming 12 months? I’ll tell you. The stocks that do something unexpected.

So ask yourself: “What does everyone expect?” And having answered that, ask yourself: “What are they going to get wrong?" There are a number of ways to answer that and it is unlikely come from hitting the books. Inspiration requires imagination and you are better to grab a bottle of wine, shut your eyes, loosen your brain and imagine the unimagined, because that’s what creates the best and worst performance. Surprise.

One way to identify surprises is to look for stocks that are in a sentiment hole or a sentiment bubble because, wherever there are strong, popularised opinions, there will be a big opportunity when the sentiment changes.

Stocks in a sentiment hole at the moment include banks, financial services, AMP in particular, and Telstra. The royal commission on financial services has created some potentially great opportunities. Some quality fund managers such as Perpetual, Magellan Financial Group and Platinum Asset Management are also significantly off their highs and waiting for a sentiment turn. When it happens they will provide quality income investments at the right price. And stocks in a sentiment bubble include resources in general, oil stocks, internationally exposed Australian stocks and a number of mid-cap “popular” stocks that are clearly overvalued but still trending up. Run with the bulls, but understand it won’t last forever.

Identify stocks where something is being taken for granted and watch for change. Don’t predict change, just watch for it. To do that you have to retain an independent, open mind, to think like the man in the moon and be prepared to do the opposite of everyone else on the planet.

Let the games begin! The challenge of identifying the next year's champions and rogues has started once again.

Marcus Padley is the author of the daily stock market newsletter Marcus Today. For a free trial of the Marcus Today newsletter, please go to marcustoday.com.au

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