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Slumping stock market unleashes its own version of fire and fury

Finally…

Is THIS the start of the stock market correction many investors have long been waiting for?

Overnight, US markets were violently jolted out of their extended period of calm, the Dow slumping over 200 points and the Nasdaq diving over 2% lower.

The VIX, the measure of volatility otherwise known as the fear index, soared 44% to its highest level since April.

Political risks rather than economic risks were at play as nervous stock market investors somewhat belatedly reacted to Donald Trump’s “fire and fury” rhetoric towards North Korea.

As US hedge fund manager Ray Dalio put it, political risk is very hard to price into markets… especially when nuclear weapons are potentially in play.

All of which makes you wonder how the stock market ever coped during the Cold War, when the nuclear threat was ever-present.

Then again, back then we didn’t have Twitter, Trump and Kim Jong-un.

Still, we made it through then, and I’d guess there’s a 98% probability we’ll make it through this time too.

If you’re the glass half empty type of person, you can always follow Dalio’s advice and consider investing 5% to 10% of your assets in gold as a hedge against current political and economic risks.

Good luck with that strategy. Over history, especially when compared to equities, gold has been a horrible investment.

And good luck with the timing of any asset allocation switch.

Who’s to know whether this mini stock market tantrum will turn into some full blown correction, or whether stock markets will quickly continue their slow, steady and inexorable march higher, as they have for well over a century?

Naturally, the ASX has followed Wall Street’s lead, falling 70 points in morning trade, wiping out almost all of this year’s gains.

The S&P/ASX 200 Index is now up just 0.4% so far in 2017.

Thanks for nothing, huh?

That is, unless you’ve ventured outside the usual suspects.

Out of the 20 largest ASX companies, only 3 are sitting on double digit gains so far in 2017 — CSL Limited (ASX: CSL) up 27%, Woolworths Limited (ASX: WOW) up 11% and Transurban Group (ASX: TCL) up 13%. The latter is an active buy recommendation for our very popular Motley Fool Dividend Investor advisory service.

The laggards are Telstra Corporation Ltd (ASX: TLS) down 19% and Westfield Corp Ltd (ASX: WFD) down 17%.

Ouch.

But scratch a little below the surface, and there’s a whole world of opportunity outside of the large, widely followed, slow growing so-called blue chip stocks.

Some of them are hiding in plain sight… like the ASX/S&P 200 Index’s top performer so far in 2017. The a2 Milk Company Ltd (Australia) (ASX: A2M) share price has jumped 120% higher in 2017 after it twice upgraded its revenue forecast.

Less obvious, although certainly not unexpected for followers of our own Scott Phillips, has been the almost 45% jump higher in the Flight Centre Travel Group Ltd (ASX: FLT) share price so far in 2017.

Last month, Scott named Flight Centre as one of his top 5 dividend stocks to buy. Many thousands of members subscribe to Scott’s investing advice, and those who bought Flight Centre shares on his recommendation would already be sitting on a very handy profit. And with a fully franked final dividend payment to come later this year.

Speaking of dividends…

Australian investors have always loved a good fully franked dividend. They love them more so now that interest rates are so pitifully low.

Almost all economists now agree the next move in interest rates will be upwards.

Thank goodness too. While property investors and borrowers have been given one almighty free kick courtesy of the RBA cutting the cash rate from 4.75% in 2011 all the way down to today’s 1.5%, savers have been copping it in the teeth.

According to the AFR

Figures from the Reserve Bank show the average interest rate on both three-month and six-month term deposits have dropped below 2% for the first time in recent months, the lowest level since the figures began in 1982.

No wonder savers are looking forward to the RBA increasing the cash rate.

That said, I wouldn’t hold your breath. 2018 is the absolute earliest you could expect the RBA to act, and it could even stretch to 2019.

And when the RBA does eventually push interest rates higher, because property prices are ridiculously high, and many Australian households are ridiculously indebted, I’m expecting them to max out around 3%.

All of which means there’s life yet in the dividend yield trade.

Especially when you can earn yields of 5% and more on ASX dividend paying stocks today, something that makes those sub 2% interest rates on term deposits pale into insignificance.

Volatility scares many stock market investors.

It shouldn’t, and here’s the simple reason why…

— Lower share prices today mean higher share prices tomorrow.

— Lower share prices today mean higher dividend yields today.

My advice is to use these periodic stock market wobbles as an opportunity to buy shares on the cheap.

Sure, keep some cash on the sidelines should markets fall ever lower, allowing you to pick up even bigger bargains should they come.

But neither panic nor be a deer frozen in the headlights. We’ve long been waiting for an opportunity to grab shares on the cheap.

Seize the moment, focus on the long-term upside potential — and the near-term income reality — and sit back and let time and the miracle of compounding returns do all the hard work for you.

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Of the companies mentioned above, Bruce Jackson has an interest in Transurban and Telstra.

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