Panic seems to be the keyword of the day for investors. As an example, CNN’s Fear and Greed index just hit 5, its all-time Fear extreme. The worst time to panic is after other people have already panicked. People who panic tend to do dumb things. “I want out. Sell everything.” To follow that herd behavior is even dumber.
It’s remarkable how little has really changed versus how much stock prices have been impacted. Basically, the economic numbers have mostly gone from great to good, and it’s surprising how much chaos that has caused. It may be that for years algorithm-driven momentum investing has been a driving force in the market, but in the fourth quarter there has been no clear momentum for the algorithm investors to follow. While there are real problems out there, they may take years to come about. The market started 2018 with very optimistic assumptions and is ending on pretty pessimistic assumptions. Could that pessimism at least create some opportunity?
All stocks are not the same – even though that is an underlying, unspoken assumption of passive funds. Because we have a market of individual stocks, it’s better to have a process to proactively get ahead of potential problems. You’re still going to have problems. Because stocks are risk assets people will panic, do dumb things, and potentially affect your stocks, but you’ll be in good shape over time if you have a process that manages risk. By worrying about risk in advance you “panic” early. Then you can view the later market panic as a potential opportunity.
I’d focus on where opportunities may be. A lot of the panic right now seems to be concerns that some growth stocks got way too expensive and also that credit markets are seeing a lot of stress.
I don’t really see much opportunity in growth stocks. Yes, they’re now a bit cheaper than they were, and could bounce, but I’d use any bounce as an opportunity to sell them. The whole idea of growth at any price is largely a product of cheap and easy financing. Easy financing has now left the building, though the momentum investors were a bit slow to notice it. And holding growth stocks into what is looking like an economic slowdown is generally a bad idea.
The growing credit stress is interesting. When people panic, a lot of babies get thrown out with the bathwater. For instance, it’s not that hard to find BBB rated companies (the lowest rating for investment grade corporate bonds) where people are selling the stock fast and hard, but their actual bonds are showing no sign of stress at all, at least they haven’t been going down in this time of stock market panic. Generally, if bonds and stocks disagree with the creditworthiness of companies, go with the debt. I don’t mean to underplay the problems – there are serious problems out there. But there are also opportunities. Again, it is a market of individual stocks.
What about those losers in your portfolio that keep going down? The easy time to sell is long gone, so now you need to make some tough decisions. First, how much do you believe in the company’s business? Is it the baby or the bathwater? If it’s a baby, consider adding to it. If it’s bathwater (and be honest – it’s easy to get things wrong in this sort of market), figure out a plan to get rid of it. Maybe you do want to just lose it now, but historically, selling heavily oversold stocks in a time of panic is a great way to be a horrible investor. It’s usually better to wait for a better opportunity, though I admit with this brave new world of high frequency trading, that path is a bit more scary than it used to be.
Perhaps the most reasonable thing to do is to compromise. Be incremental. Sell a bit now or after a small bounce, then wait and see if better opportunities come. When they come, take advantage and sell some more.
At year-end, it’s easy to imagine a lot of chaos, but I think that chaos works both ways. People are unloading stocks willy-nilly, either because they’re liquidating or they just want to look like they own the ‘right’ stocks for their year-end reports. That’s creating a lot of downward pressure, but it can also be like pushing a ball under water. Things like oversold and overbought are by their nature mean reverting, as is volatility. It may take no more than a turn of the calendar to change perspectives, and there could also be positive occurrences. For example, pension plans are likely to be fairly large, mechanical buyers as they re-weight their asset allocation. Sometimes all it takes after a period of extreme selling is for the selling to just take a little break.
How bad can things get? This reminds me very much of 2000. Things were pretty bad for the favored sectors that had been soaring in previous years, but for the unloved sectors there were opportunities. People have a strong tendency to assume that whatever happened lately will continue indefinitely. Do you really think stocks will keep losing 15% a quarter? Even more important, even if they do, when the stock market starts giving you the opportunity to buy solid companies with 5% yields and single-digit P/Es, you’re probably going to be hard pressed to get in too much trouble in the long term. That’s another thing that reminds me about 2000 – I thought I’d never see deals like that again, at least not for a very long time. We did fairly well with those opportunities last time; I’d like to think we can do it again here.