After 3 days and a mild 3% correction, investors are now remembering what it feels like to lose money in the stock market. It’s been a while since we’ve seen any real selling pressure so no doubt, this seems new and awful. By Friday of last week, the selective selling of the previous month turned into a round of “get me out” and more indiscriminate selling. These panic moments can lead to more selling but often mark at least a short term low in stocks. Is this the end of the correction? Read on.
When I’m feeling afraid for my investments (yes I get afraid too), I find it helpful to tear apart the fear. How much is based on solid evidence versus getting caught up in the moment? What am I really afraid of? In doing so, I am almost always relieved to find that the situation is not as bad as my initial perceptions and better yet, I begin to see opportunity. Let me first digest the fear side, and then let’s talk about short term and longer-term opportunities developing now.
What is fear for investors? Fear is not about losing money. That is in the past and it shows up as anger, resentment and regret. These are part of investing and we try to keep these emotions contained by way of containing losses. No, fear is really about the future, specifically not knowing the future and wondering if the future is going to be bad or worse than previously expected. Effectively, for investors, we are talking about fear of the unknown. Obviously current events have a way of projecting forward in our expectations. Last week, I noted the titles of all 2014 forecasts being nothing but happy, bullish and optimistic. After last week’s declines, I wonder what we might expect to see and hear now? I bet no so much Bull. Also embedded in our fear is a sense of being helpless. If you are in a position where you have no sell side criteria and your investment strategy is one of hoping for positive outcomes, then no doubt you are feeling more fearful. What if the market unwinds? When will I sell? Who will decide? What day? Which stocks? These are fearful thoughts going through your mind right now in the absence of a strategy.
In our shop, all positions have sell side criteria. Some are tied to the markets via indices so we can use market technical indicators to suggest when we should adjust (cut) our market exposure. Others are more specific to the individual holdings like our bond and individual stock positions. Last week, several of our positions broke down through our “stops” and were sold to cash. That is called risk management and it follows a predefined strategy. I don’t know the future but I do know when my investments are moving against me. Having a system that creates an action item helps one manage fear because we know that we are in the driver’s seat and not simply a victim or what may or may not happen in the future.
As I continue tearing into my fear, I do find real concerns based on real evidence unfolding now. These are things I can focus on, measuring them and addressing them with respect. One is the unintended consequence of the Fed’s recent activity on foreign currencies. Globally, foreign currencies have been crushed in the last week on the basis that the US Federal Reserve is not going to be flooding the global markets with as much cash as we have seen in the last several years. A currency crisis is not fun, I’ve been through a few and they can have a significant negative impact on stocks, both domestic and foreign. Selling is driven by foreign investors looking to repatriate their wealth to their own domestic currencies, which involves the sale of all things – good and bad. I have little doubt we are seeing that type of selling now. US investors sort of get sideswiped as they really don’t have the same currency concerns and yet all stockholders pay the price. Currency driven stock declines can be nasty. However, they are also quickly recovered as currency exchanges whip rates back to historic norms after the selling. In 1998 the Russian and Asian currency crisis caused a 26% decline in the S&P 500 and complete recovery of the same in less than 60 days. Tums anyone?
I am also concerned about the impact of congressional bickering regarding our own spending (debt) limit in early February and the general stage of the investment cycle where investors are looking for reasons to take profits after such a bountiful 2013. I am not currently concerned about any other aspect of the financial markets. With that said, let’s look at the situation from an opportunistic perspective.
In the short term, I do not see an immediate opportunity in stocks. That is nice of way of saying; this market is likely to go lower before we see a sustained new uptrend. Based on cycle work alone, which is a blunt instrument for trading, we are looking all the way out to the late summer or early fall as the most likely point for stocks to resume the strong bull market uptrend of the last four years. Remember, we have been calling for a “Garden variety” bear market this year during the first two to three quarters. This is not the type of bear market we have see in more recent years with losses of 40-50%. I am talking about a more cyclical, technical, profit taking type decline, perhaps using a currency crisis as the catalyst that simply erases much of the bullishness in the system and resets prices back to a more attractive entry point. It could be 10%, 15% or even 20% but I would guess at the lower end of the loss spectrum. The opportunity to buy stocks aggressively will happen again in 2014, but later. Stay focused on risk management and capital preservation for now.
Right now, I think there is a real opportunity in the income world, not Treasury bonds but higher income bearing securities, like those found in our Retirement Income and Freeway High Income strategies. 2013 was an unproductive year for these strategies, which gained less than 2% in the year. In the process, the opportunity was reset. Investors sitting on giant piles of cash in bank accounts earning nearly zero interest could entertain adding money to either of these two accounts which are back on a track of generating 8-10% annualized returns since becoming fully reinvested just 30 days ago. Remember, our “income” strategies have very little to do with Treasury bonds or any perceived risks here. In fact, one of our core holdings are floating rate funds, which actually move higher in price as interest rates go up (if that’s is your concern). If I had cash in the bank that is earmarked for investing, I would add SOME to income models now and wait until July or August to allocate the rest to my favorite stock strategy. Personally, I do not carry much cash in the bank and never have, as I don’t like lending money for nothing. In 10-15 years when banks are again paying 5-6% interest on deposits, I might reconsider.
I’ll finish by saying this opportunistic statement; the bull market in stocks that began in 2009 is not over by any means. Longer-term technical guides that warn of a bull market peak 6-9 months in advance are nearly absent. In the short term, we are long overdue for a corrective cycle but ultimately it should be just another great buying opportunity. Earnings this quarter are coming in ahead of expectations by the widest margin in over six quarters. Earnings season is not over yet however. Revenue numbers are also strong. If prices decline into the fall and corporate profitability continues as is, we could be staging for quite the launching pad for another very strong move higher in stocks well into 2016.
Cheers to that! Have a great week