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ABC News
ABC News
Business
business reporter David Chau

Investors warned against 'buying the dip' in market downturn as ASX drops 10pc for the year

The Australian share market is down 14pc from its August record high. (REUTERS: Brendan McDermid)

"Buying the dip" is no longer an easy way for inexperienced traders to make a quick buck on the stock market, a seasoned stockbroker has warned. 

That is despite the ASX 200 being in correction territory, having plummeted by more than 10 per cent (or roughly $250 billion) in the past year.

It is a catchphrase among traders that, basically, means buying a stock for a "bargain" after its price has fallen sharply and hoping that it rebounds.

"I think all of us need to unlearn the 'buy the dip' mentality as that is a dangerous proposition in a falling market environment," said Michael McCarthy, the chief strategy officer of Tiger Brokers.

It is a strategy that worked well for many who started investing in stocks after the COVID-19 crash of March 2020.

That is because markets were frequently hitting new record highs, as central banks (like the Reserve Bank, the US Federal Reserve and others) slashed interest rates to zero and collectively flooded the world with trillions of dollars worth of stimulus to offset the economic damage wreaked by the pandemic.

Stock markets in Australia, the US and Europe have plummeted since January 2022. (CommSec)

But now markets are falling sharply as the RBA and its global counterparts are lifting rates aggressively and turning off the money taps, in a desperate attempt to bring inflation down.

In the 2021-22 financial year, the heaviest losses were felt by local tech stocks and buy now, pay later companies.

The values of former "market darlings" Zip Co, Sezzle, Megaport and Tyro Payments have plunged by around 70 to 97 per cent each during that period.

"It's when investors buy into a stock with an optimistic outlook. But that optimistic outlook fails to materialise and the share price falls.

"However, instead of cutting the losses and walking away, investors buy more of the same shares."

Beware 'fashionable' lithium stocks 

Many of the best-performing ASX stocks in the past year were commodities exporters, driven by a surge in the prices of lithium, oil, gas and wheat.

The biggest beneficiaries were Core Lithium (+319 per cent) and Allkem (+69 per cent), coal miners Whitehaven Coal (+164 per cent) and New Hope (+112 per cent) and grain trader GrainCorp (+83 per cent).

However, Mr McCarthy believes many of the top performers in the past financial year may do poorly in the year ahead.

"What's often the case in markets is what's fashionable at one stage becomes a worst performer once that fashion turns.

"There's certainly a lot of interest in the lithium space because of its potential use in electric batteries.

"But the fact that copper — which is just as important in battery manufacturing — has not performed as well does suggest there are elements of 'fashion' to that outperformance from lithium stocks."

Copper prices plunged to a 16-month low last week amid concerns of falling demand, as each successive rate hike from central banks raises the likelihood of an economic downturn.

Australians are seeing thousands of dollars wiped off their superannuation(Nassim Khadem)

Russia's war in Ukraine has led to a spike in coal prices, which has seen the fortunes of coal companies reverse.

"Coal was doing absolutely dreadful last year, but now they've gone from the basement to the penthouse in one year," said Hugh Dive, the chief investment officer of Atlas Funds Management.

"This time last year, people were worried they'd be stranded assets, and China put a ban on Australian thermal coal. It's a different story now."

'Price of money is going up'

"Any business that is receiving consistent income through the rate-hiking cycle could be very attractive," Mr McCarthy said.

"It's one of the reasons why we're seeing consumer staples, for example, getting good support. Most supermarkets tend to do okay, even during a recession.

"Medical exposures could be very useful over the coming year. You don't put off having a heart operation because of the economic outlook.

"So I'd be looking for businesses that are exposed to those industries … that are likely to continue to function well and provide cash flow, which is one of the keys in an environment where the price of money is going up."

As for what is unlikely to perform well in the coming months, Mr Dive says it is best to avoid unprofitable businesses with lots of debt, and "high growth" companies, which are expensive when you compare their share price with how much they earn. Many tech startups fit that bill. 

"A company that doesn't have much earnings today — that has the promise of large earnings in the future — when interest rates go up, their earnings get discounted.

"And those tech earnings — that are maybe large profits 10 or 15 years in the future — are now worth less."

"A rising interest rate environment favours companies that are actually earning money today, rather than hoping to earn money in the future."

Industrials, chemical companies and insurance stocks, generally, are what he expects to do well as rates continue to climb.

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