Periods of market volatility are a test. It’s times like the present that tests confidence in how well investment strategies are constructed. Normal volatility requires that you have an iron clad stomach at the best of times, and an even stronger one during the present correction magnitude movements. The present investing environment is tense. How do you act during this period of heightened market volatility? Do you embrace it, investing opportunistically? Do you run from it, selling in panic or worse yet, thinking it’s too late to sell a downward sliding portfolio? These periods test the level of your conviction in your investment choices. Choices that you’ve made in the past and still hold long. Based on the domination of the sell side over the past 12 months, it seems that many people are not convinced at all about their choices. Suggesting that many may have failed or be failing the volatility test.
Passing the Test
I think I deserve a “B” on this exam, stretching it, maybe a “B+”. The S&P started the year at 2043.94 then proceeded to drop 10%. In comparison my stock portfolio holdings dropped approximately 6%, beating the benchmark. So, I think a B+ is merited. I’ve passed the test largely because I’ve executed on the value investing principle of margin of safety. The margin of safety is a critical factor in my investment strategy that allows me a certain level of objectivity when all hell breaks loose in financial markets. With the built in margin of safety cushion, as a value investor buying low, permits me a certain level of peace when major price fluctuations hits the equity markets and portfolios.
What’s Going On? Investors Can’t Decide
The present period of uncertainty is global. The associated risks emanate from the world’s most important economies. The instabilities are spawned by many conflicting economic indicators: looming bond defaults, US industrial production numbers up 0.9% this month but down from last year, central banks policy divergence, Fed tightening (or loosening with a negative interest rate), WTI futures testing sub $30 limits, unemployment rate at 4.9% but jobs created are within retail and other lower wage areas, global growth forecasts being downgraded, the Chinese economy being on life support, European financials are a mess, etc… The list of good news/bad news goes on. Over the past 52 weeks, investors have responded to the conflicting indicators by pushing the S&P down 15.2% towards bear market territory. The market volatility index, the Vix, as well, has reacted with a wide 12 month range of 10.88 lows and a high of 53.29. As if to emphasis the point, spot gold is rebounding strongly off a milti-month low of $1196/ozt. Essentially, investors believe that the major economies may dip into a recession or…maybe not.
Conclusion: Prep for the Next Market Volatility Test
The silver lining to major market volatility is that it provides investing opportunities. The fact is that the markets have not had a sustained upward movement for well over one year. Recent gains, including this weeks’ 3 session 5.3% rally, still put the markets down for February. It is worth noting that the bounce has been on low volumes. With a focus on company fundamentals, I, for one, am checking markets to identify if any of the positions I’m interested to include in my stock portfolio have moved into my entry point target zone. All in line with my investment strategy. Purchases I make now will help me pass the next round of tests.
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I don’t think people should buy at the top of a potential bear market. The trend is downward and let’s face it, the markets are overvalued in general. We should be finding things to short sell instead. For instance, Twitter and Linked In are good places to look. Their 200 day moving average in downward (well in advance of the S&P), the general markets are trending down, these companies are overvalued, and their user growth is slowing (the nail in the coffin of a tech bubble). That’s four headwinds against them. By shorting, we can profit on the way down and then start buying value plays afterward. But these are only examples of numerous good short plays. Right now is too soon to go long. If I turn out to be wrong, we could easily cover our shorts and go long again. Check out Leucadia National Corp. This famous value investing company is already 50 cents on the dollar of its book value. I can nab this great deal precisely because I kept my cash and didn’t go in when it was 70 cents on the dollar. Patience pays! Don’t be long all the time.
Thanks for the comment. This is a clear example of how investing is a personal endeavour.
I’m sure you didn’t mean to suggest buying in a trough is bad. What we both probably disagree on is whether there is significantly more downside in the market. Downside risk is a valid point to debate. I, however, mitigate this potential downside risk by using a phased approach to going long, buying into a position over time.
On the question of shorts. One of my key investing tenets is that I need the ability to sleep well at night. Short selling would keep me awake with worry. I am personally not comfortable using shorts as the potential unlimited liability risk is incalculable. If my short-sale analysis is correct then all is good but if my analysis is incorrect then I’m unable to properly calculate the risk to the rest of my portfolio. Of course you can limit your potential losses with stops but I’m a pretty straight forward investor, I simply want to own solid companies with solid growth prospects.
Trends. I don’t follow them. Any position I move on has been under observation for a while, sometimes as long as 4 years (that’s patience). So, while trends are good for momentum plays, my investment horizon looks out 10-15 years which is unsuitable for trend following. It’s more effective as an investment strategy and more profitable for me to find value plays in stocks which have fallen out of favor for all the wrong reasons. I’ll then gain on the appreciation and dividend.