What happens when investors sell stocks? Well, the immediate answer is obvious – they avert loss by stepping out of harms way. While this is true, and on the surface seems simple, suddenly a number of related questions come to mind that muddy the equation. For example, how do you know you’ve sold at the right price? Do you sell one stock, or all of them and how long do you stay “out of the market”. Once you’re out of the market, how will you know the optimal moment to buy? Finally, how do stocks fit into your game plan as a result and are you updating it to stay current with market conditions?
While many professional investors have a thorough sell (and buy) process, tools and rules, others do not. They often are active in the market without any formula that indicates a good, or bad price level. The process becomes behavioral and primarily based on what everyone else is doing. Just because there are a lot of swimmers in the water doesn’t mean there are no sharks. Fear is one emotion that is impossible to control, and when it takes hold, you no longer make rational decisions.
Our process involves active asset allocation and investment management. We guide our clients to a blend of asset classes that allow for an optimized return while limiting the risk to an acceptable level. Risk is inherent in virtually all financial assets, and the primary risk for most is price volatility. We actively review the price levels we feel are appropriate for each asset we own and when they are over-priced or the facts change, we sell. Part of our job is the difficult task of discerning the noise from the useful information.
August saw stock prices fall by 6.26%, leaving them down 2.88% year to date as measured by the S&P 500. Although prices have ping-ponged up and down all year, we are now looking at a “correction” in prices with this recent drop. The term generally applies to a market and markets correct now and then. A market decline of 10% or more is considered a correction and prices have not declined like that since August 2011. On a less frequent basis, we encounter what is known as a bear market. Bear markets (stocks falling more than 20%) thankfully do not come along all that often in the US stock market. For example, of the 25 bear markets since 1929, 12 took place during the great depression. It was a horrible time to be an investor. Since 1946 and the start of the baby boom, things have improved. Due to a number of changes in the financial markets, both economic and stock market trauma have tempered. The most recent bear market was the financial crisis beginning in 2008. It has not been put to bed in many investors’ minds.
As I said last month, August and September are seasonally the most difficult time of year to own stocks. I think there is a good chance the volatility we experienced in August continues through September. The unrest and fits of panic may drag out. Ultimately, prices fall to a certain level, some time passes and out of nowhere investor confidence begins to repair itself. All of a sudden, the common sentiment swings to the view that valuations are fair, cash flows are sustainable and the outlook is glass-half-full.
In my opinion, nothing about the economic outlook has changed over the last month to dim my interest in owning stocks and bonds. The growth tilt we’ve seen in stock behavior remains in place and we maintain our focus on owning quality growth stocks at reasonable prices. I do not agree with the knee jerk response to buy dividend yield whenever fear strikes. And, while China did devalue its currency, the US market did not drop as a result of China. The sell-off was a long time coming, irrespective of the narrative we attach to it.
Attaining your investment objectives hinges on a well-managed portfolio, constant attention, and a clear game plan. Change is certain and we need to decipher and address it. In this context, if you are uncomfortable with the markets or with the news flow you are receiving, please call us now. We have been in contact with many of you, but certainly not everyone. I am more than happy to review your asset allocation with you to make sure your portfolio is appropriately configured. It’s important we talk in order to square up your game plan – so fear doesn’t win out.
Bruce Hotaling, CFA
The views and opinions stated herein are those of Bruce Hotaling, are of this date, and are subject to change without notice. Information contained in this report was received from sources believed to be reliable, but accuracy is not guaranteed. Investments are subject to market risk, including the possibility of loss of principal. Past performance does not guarantee future results. The S & P500 is an unmanaged index of 500 widely held stocks. Investors cannot invest directly in an index. The PE ratio (price/earnings) is a common measure of relative stock valuation.