By Michael McCarthy

The Australia 200 Index is now down by more than 10% from the recent highs around 6,000, putting it in “official” correction territory. Worries about Chinese demand, rising US interest rates and a sluggish Australian economy have investors concerned about share prices. Momentum is negative, or neutral at best.

These are the factors that mean it is likely a good time to buy for long-term investment.

Investors who follow the crowd end up with average returns – that’s just mathematics. Investors seeking superior returns must be prepared to do the extraordinary. One way is to follow the famous dictum – to be greedy (buy) when others are fearful, and fearful (sell) when others are greedy.

It’s clear that fear levels are elevated at the moment. The local Volatility Index (XVI) is sitting close to 20%, down from recent highs, but still well up from the average of the last few years which is closer to 14%. These higher readings reflect higher demand for share market “insurance”.

Headlines are dominated by doomsayers, and surprise events, such as the Chinese Yuan devaluation, immediately spark selling, despite the fact they could actually support share prices.

If we accept fear levels are elevated, it’s reasonable to ask if there are there other factors that support a “buy” call. One of the most important measures of share price levels over the last three years is the respective dividend yield. Dividend yields can be calculated for an index, as well as an individual share. When the S&P/ASX 200 index sat close to 6,000, the cash dividend yield was around 4.2%, plus franking. Now, with the index closer to 5400, the dividend yield is closer to 4.9%, plus franking. Many investors consider this attractive particularly as cash rates are 2% and the ten year bond yield is around 2.75%.

In value terms, the Price to Earnings ratio (P/E) is also at more attractive levels. At around 14 times forecast earnings for the next year, it is not cheap relative to historical levels, but is not expensive either.

Perhaps one of the most compelling arguments for the positive longer-term outlook for the share market is the significantly lower levels of the Australian dollar. While further falls are possible, downside risks from 73 US cents pale in comparison to possible eventual rises back over one US dollar.

This makes Australian shares much more interesting to global investors.

In short, it’s time to have a good look at those high quality shares you don’t already own. This of course means the answer to “what to buy?” is different for each investor.

Dyed in the wool contrarian investors are currently looking at mining and energy stocks, given the historically low share prices and overwhelmingly bearish sentiment towards oil and iron ore at the moment. Others may be looking at Woolworths as it trades closer to $27 than $37. Some may be considering stocks that have fallen following positive results announcements that didn’t meet high expectations, such as Cochlear or James Hardie. Whatever the choice, it’s time to examine the radar.

CBA entitlement (rights) offer

Another way to increase share holdings for existing Commonwealth Bank (CBA) shareholders is to buy under the current share offer. Investors have received one “right” for every 23 shares held. This right can be sold on market (Code: CBAR) or “exercised” before September 8, allowing the rights holder to buy one share of CBA at $71.50. Investors who are already highly concentrated in banks, and/or CBA, may consider selling their rights on market before the end of trading on September 1, and investing the cash they receive elsewhere.

However, investors not over-exposed to CBA may consider taking up the rights. The purchase price of $71.50 compares favourably to the all-time high $96.27. Even adjusting for the recent dividend, a high at $94.05 means the offer is still around 24% below levels seen this year. Additionally, at current dividend estimates, buying at the offer price represents a cash yield above 6%, or better than 8.5% once franking is taken into account.