Why you can bank on the ASX

Did you know that the big two miners and big four banks account for over 40% of the S&P/ASX 200?

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Did you know that the big two miners and big four banks account for over 40% of the S&P/ASX 200 (XJO)(^AXJO)?

When these companies’ share prices drop, the Australian market wobbles. Jitters follow, then it all comes tumbling down. As we’ve seen this past week, resources stocks pulled down the index, with Rio Tinto (ASX: RIO) and BHP Billiton (ASX: BHP) dropping 3.7% and 5.1% respectively. This sent shockwaves out across the market and together with a minimal change in China’s GDP forecasts, it was enough to scrape 1.5% from the index.

The efficient-market hypothesis dictates that markets are information efficient, meaning share prices realise any new information that is added to about companies listed on stock exchanges. It is the central concept behind trading stocks on any exchange. The ability of the market to realise new information via media sources and company announcements, means it is integral to pick stocks that are likely to become more profitable than they are now, before other investors do so. This is the key behind any successful investment portfolio but it’s not what presented itself on the ASX this week.

Why should have bought resource stocks

If you follow the efficient-market hypothesis, you should have sold your resource stocks last week, in February or even better, in 2011. Selling at share price peaks is a sure way to make money. This week, investors sold down stocks that had no reason to go as low as they did because we didn’t know where they were headed in the future and it all seemed doomed, so we sold.

The four pillars of the Australian economy

Many Australians think their money is no safer than in one of the big four banks. Who would doubt them? Some have credited Australia’s big banks like the ANZ (ASX: ANZ), Commonwealth Bank (ASX: CBA), National Australia Bank (ASX: NAB) and Westpac (ASX: WBC) as some of the safest in the world. However, investors are running to the safe havens either too early or too late. We can see this if we just monitor the share prices of the companies mentioned across a timespan, let’s say, this week.

From Monday til Thursday, resource stocks got hammered and returned negative price movements every day. On the contrary the big four banks were largely flat or positive. Today, the two switched sides, with BHP and Rio up over 2% and 3.5% at time of writing. Alphabetically the banks are down 1.45%, 0.19%, 1.5% and 2.06% respectively.

Why I banked on Rio

This week I wrote that Rio could be a buy for savvy investors. The long term will tell and I don’t want to say I told you so, but at a P/E ratio of just under 9.5 I just couldn’t resist. The long run volatility of its biggest produced commodity (iron ore) might be of concern but it ticks all my boxes. Security, growth potential, dividend yields and its cheap! That’s why I banked on it.

Buy cheap, sell expensive

The time to sell resource stocks was not this week but I couldn’t tell you when the perfect time to buy them was. I focus on finding cheap stocks, the rest is out of my control. When company announcements are released and say something like ‘production downgraded’ it’s often too late. Efficient markets will already realise the reduction in potential of the stocks but I’m not one who likes to lose money.

Following Warren Buffett’s two investing rules has enabled me to have a short but successful time on the Australian Stock Exchange, but before I tell you his secrets there’s one important thing to add. Whether you trade options or stocks this key idea is fundamental to success. Only buy companies you want to own and you have absolute faith in. As the Motley Fool’s Scott Phillips said earlier this week ,“we only ever have to buy something when the odds are in our favour – there’s no penalty for patiently waiting”.

With that in mind, we look to remember Buffett’s two rules:

  1. Never lose money, and
  2. Don’t forget rule number 1.

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Owen Raszkiewicz owns shares in Rio Tinto Limited (ASX: RIO) and ANZ (ASX: ANZ).

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