Shares: Golden opportunity for blue-chip buys

ONE OF the simplest but most effective stock market strategies is to buy a collection of blue chips every time there is a significant stock market setback. Strong-minded investors could do well by making it a rule to buy shares only after a setback, or at least to reserve funds against such opportunities.

The important point is to buy shares in companies with plenty of turnover and balance- sheet strength. As long as they do not go out of business, it is a near-certainty that at some point in the medium term they will go on to scale new peaks and the investor will reap rich rewards in dividends and capital gains.

One question is how to define a significant setback. The question would have evoked a hoarse laugh in October 1987, when share prices were falling by 10 and 20 per cent a day. But the position is not always so obvious. A technique associated with technical analysts of stock markets, but rooted in common sense, is to measure how overbought or oversold shares are in general. One method I find helpful is to look at how an index is performing against its nine-month moving average.

The trick is to buy when share prices are well below their moving average. For example, between 1978 and 1986 it paid to buy aggressively whenever the FT-SE 100 index fell around 100 points below its nine-month moving average. In 1987 the rule-book was rewritten, when the index dropped more than 600 points below its moving average. However, the decline was so fast and furious that it is unlikely anyone could have bought much too early.

Since then the pattern has been for shares to be oversold when the index is about 200 points below the moving average. Combining the two rules, there have been five buying opportunities since 1978: in 1981, 1984, 1987, 1990 and 1992.

On each occasion purchases would have been highly profitable because of the long- term rising trend in the stock market, which means recent 'highs' have been far above all earlier levels.

I suspect also, although I have not done the sums, that a speculator who bought long- dated, out of the money FT-SE 100 traded call options could have made some serious financial killings.

Where are we now? The FT-SE 100 peaked at 3538.2 on 3 February 1994 and traded as low as 3076.9 last Tuesday, for a decline of 458 points or 13 per cent. The nine-month moving average is 3275, which means the index has traded within a whisker of 200 points below the average. Clearly it could go lower; if a majority of investors didn't expect that, it would never have dropped this far.

Further weakness on Wall Street could drag our market down. But investors would be justified in believing that right now we have the sixth FT-SE 100 buying opportunity since 1978. Gamblers should consider buying a traded call option on the FT-SE 100. They could lose all their bets, but there is a good chance of profits of several times their investment. More patient investors should stock up with blue chips or invest in an appropriate unit or investment trust.

The next question is which shares to buy. I looked at one share, Marks & Spencer, to see whether its share price performance reflected the overbought / oversold pattern of the FT-SE 100. Individually the retailer's shares became seriously oversold in 1979, 1981, 1983, 1984 and 1987. Since 1987 it has never become heavily oversold and is only mildly oversold at present. But that suggests good relative strength, so is probably bullish. That looks right.

The group is firing on both barrels, with its superb food halls and a value-for-money offer on fashionable clothes. At the same time, pressure to curb edge-of-town retailing should reinforce the attraction of the group's portfolio of high street sites.

Last but not least, it is starting to become seriously successful overseas. The shares look terrific value at 4071 2 p. Analysts' forecasts suggest earnings per share of 21.2p for the year just ended, and 23.1p to 31 March 1995, implying that the prospective price-earnings ratio will soon be under 18. That compares with a median p/e for the shares since 1978 around 20.

Other leading shares that should prove good investments bought at current levels are BAA at 1,000p, BTR at 3601 2 p, GUS 'A' at 607p, General Accident at 620p, Granada at 551p, ICI at 789p, Rank Organisation at 397p, Rentokil at 228p, Siebe at 592p, P&O at 693p and Thorn EMI at 1,061p.

This is a list, including Marks & Spencer, of 12 well- managed leading companies which should benefit from global economic recovery, while achieving good trading results even if times stay tough.

But the individual selections are not the crucial element in the strategy, which is more about when to buy rather than my more usual emphasis on what to buy. Readers who like the look of other FT-SE 100 stocks, or who prefer more emphasis on higher-yielding recovery shares, could change some of the shares while still pursuing a logical and, let's hope, profitable investment strategy.