By Michael McCarthy

Now that the dust is settling on last week’s global share sell off, it’s time for investors to start picking through the wreckage for beaten up blue chips.

Investor nerves remain taut. The share market reaction to a rate rise in the US is still an unknown, and fears about growth in China are likely to arise again in the future. Volatility levels remain high – the Australian VIX is sitting around 26% - well up from the longer run average, which is closer to 14%, and indicating fear levels are still high. While oil prices are higher, weak base metals prices indicate global industrial sentiment is also low.

However, lessons have been learned. The stock market in China is not the economy, and the economy is not the stock market. Share prices can rise with US interest rates, despite the impact on corporate costs and company valuations. While the bears continue to growl, recent downward market moves are looking more like a correction than a crisis.

Investors who share this view may be actively seeking opportunities at the moment. From peak to trough this year, the S&P/ASX 200 index fell more than 17%. Many shares that make up this average performance fell by substantially greater amounts. This means many blue chip stocks are at “value” levels.

A common feature of local portfolios is a narrow concentration in higher yielding stocks. For many investors this is expressed through larger positions in the big four banks and Telstra, with a number of peripheral investments. This positioning paid off very handsomely in the lead up to March this year, both in terms of capital appreciation and franked dividend streams. The falls in the market, and bank stocks in particular, since mid-April illustrate the risk in such a narrow portfolio.

Diversifying across the sectors of the market spreads risk. A large number of investors are underweight commodity exposed shares – once again, a very useful investment stance over recent times. However, with energy and metals prices now at substantially lower levels, and mining and oil stocks reflecting these moves, it may be time to re-think. Adding to the case is the recent underperformance of some truly global companies:

Daily – Australia 200 Index vs BHP and Woodside

The background (grey) is the S&P/ASX 200 Index. The pink line is BHP, the green is Woodside. Since September last year, the Index is down around 8%, but BHP (-30%) and Woodside (-25%) have slipped significantly more.

Both BHP and Woodside are “world class”. BHP is the world’s largest listed mining stock, with a commodity portfolio focussed on four main commodities and diversified around the globe. Woodside has some of the world’s largest gas fields, with a strong operating record, strong production and huge reserves.

While bearish commodity commentary abounds, the size of the price falls and recent positive price action, point to the notion that if we are not at the bottom of the commodity cycle, we’re very close. Whether or not adding Woodside and/or BHP to a portfolio is the right move is a decision for the individual investor.  But given a narrow portfolio, and the stage of the commodity cycle, it’s something all investors should consider.