Reports say the two-week stock sell-off is fear-based and likely to continue. Some commentaries do attempt to identify attractive stocks, but most then say to wait for stocks to sell down further. Is that the proper view and good advice? Is it what the professional investors and fund managers are thinking and doing? No, and here's why not and what steps they are taking.
Disclosure: Author is fully invested in U.S. stocks and U.S. stock funds
A good example of what we are hearing is “Cramer's game plan: Cash is king next week.” In spite of stocks being down (or perhaps because of it), he believes fear is in control, not fundamental thinking. However, the Fear/Fundamental ratio is fickle and has a way of unexpectedly and dramatically reversing. Therefore, trying to outguess investors’ mindsets is fraught with risk. A better approach is to take the steps professionals follow in such times.
First, focus on individual securities. When markets fall, commentary tends to clump all stocks and/or types of stocks together. Investors, too, often focus on the allocation to stocks, too often determining a rationale for reducing stock risk at the wrong time. The resultant blanket selling can toss the “baby out with the bath water,” producing attractive pricing for selected, individual stocks.
Second, be willing to act “too early.” Professionals know that just when a sharp sell-off looks ready to plummet further, it can suddenly rebound. When it does, it can jump 10% or more, leaving willing but hesitant buyers behind, now hoping for a downward recurrence that fails to occur. Therefore, professionals buy when opportunities present themselves, not when they think the market has hit bottom.
Third, ignore analysis of investor emotions. Identifying “capitulation” and similar times comes after the fact. Last week’s dramatic selling, especially on Friday (Jan 15), could well earn it a label. Therefore, the best strategy is to ignore articles forecasting more fear-based selling ahead, particularly those that say to wait “a bit longer” for stocks to fall “a bit lower.” Too often, those are the famous last words of a failed strategy.
Fourth, adopt a contrarian stance. When markets are weak, the media focuses on the negative. Culled are the positive possibilities, producing the impression that there is no light at the end of the tunnel and, thus, stocks are doomed to fall further. Such imbalanced thinking necessarily encourages selling, meaning lower prices and an even better return potential for willing buyers.
Fifth, deal with negative emotions positively. All investors are susceptible to worries, including the professionals. The best remedy is to recall the investing truism: Negativity and worry today are the ingredients necessary to produce the low prices that are the source of outsized returns tomorrow.
One more item to consider
Just like the observation, “You can’t fight city hall,” stock investors need to remember, “You can’t fight the market.” In 2016’s first two weeks, the S&P 500 is down 8%, the DJIA is down 8.3% and the Nasdaq is down 10.4%. The declines have hit everywhere, with 90% of the S&P 500 stocks down and 40% down 10% or more. Obviously, most investors have lost money. However, those losses do not mean a failed investment plan. To judge that, we need to look at relative performance – that is, how performance compares to the overall market. Here is an example, using the five stocks I mentioned in “What Is Missing From 2016 Investment Advice? Optimism And 'Cool' Stocks” (Jan. 4):
It is only two weeks into 2016, but so far, so good for this five-stock portfolio. Could the market continue down? Yes. Could the relative performance turn negative? Of course. However, the relative picture is how we should judge our strategy as we move through time, not simply by looking at whether we are making money today or not.
The bottom line
The market’s behavior has been terrible and the news now matches investors’ emotions – negative with fears of worse to come. But, then, that is always the mindset at market bottoms, so there is no takeaway from such commentary. Instead, follow the professionals’ steps for taking advantage of this market, and track progress using relative returns.
