It’s been sometime since the market became “lively” again. But compared to 2008 or 2001, this is nothing. Still, I fully understand that it can make investors nervous, and worse, subject to make emotional decisions.
Most people heard the old adage about being happy with lower prices to buy, as that’s the first step of the “buy low, sell high” motto. And right now, lots of good companies are on sale, providing bigger dividend than before, so this should bring the same smile as the shopper waiting for Amazon Prime Day or Black Friday promotions. It’s obviously easier said than done because investors are still emotionally attached to their investments. They are still afraid of losing their life savings and the media does a terrible job fueling this fear to feed their agenda which is to sell more clicks (because they are a business too).
I understand the fear, this was one of the worst weeks in stock history. Major US indexes have lost between 7.2% (Dow Jones) and 8.7% (Russell 2000). S&P 500 sectors have lost between 5.3% (utilities) and 8.7% (communication). Drawdowns are now about 17% for the Dow Jones, 18% for the S&P 500, 21% for the Nasdaq 100 and 26% for the Russell 2000. If I can put my “investing hat” aside for a moment, and replace it with my “trading hat”: The S&P 500 fell through the 2550 support without stopping, the 2400 support is a weaker one and unless a miracle happens, it is unlikely to hold: prices and volumes on Friday are strongly pointing to the downside. As a trader (not an investor), I’m looking at the next support is around 2300 – look at the chart below for the uptrend that started in 2009, after the latest big bear market in 2008:
And these prices might not even hold. Again, as a trader, why do I care for support and resistance? As Fred Piard elegantly put it, they are not magic numbers, it’s psychology: previous pivots are used by traders and institutional investors as stop loss and take profit levels. Every time a support is broken, it triggers a cascade of stops, amplified by margin calls (or fears of). It happens for supports of indexes, sectors (because of ETFs and futures) and individual stocks, with a negative feedback effect among them. It also explains why the market may enter a deep correction without a recession or even without a black swan: what we are seeing is a butterfly effect in a nervous market. In 1987 Black Monday resulted in a 30% drop far from any recession. The story was different (it was a big black swan), but there is a common point: it happened after an outsized rally like what we have witnessed from November 2016 to January 2018. In 1988, the recovery was steady and took about 18 months.
So the picture above indeed points to better sales (lower prices) ahead. Only 32% of S&P 500 stocks is above their 200-day simple moving averages.
Now let’s put our investing hat again, and why I’m not worried that the market is so gloomy:
Dividend stocks are cash machines. They continue to produce income. Growing income as companies raise that payout every year. As an investor, you don’t want to sell that, even more so when many of them are trading below their intrinsic value.
Even though I’m always 100% invested, I try to live with 90% or 80% of my income and “pay myself first” by setting aside that 10% to 20% to investments. If you are in the accumulation phase, you should strongly try this approach, always set aside a portion of your income to grow your wealth. That, combined to the dividends coming every month / quarter, will provide extra cash to be reinvested, which in turn will provide even more cash, and so forth.
Since I’m always 100% invested, I can’t buy much now. But I couldn’t buy much also when the markets were going up or sideways. It’s no different now. Dividend growth investing is not meant for sale, and therefore, it doesn’t matter what the market or your portfolio does. You are not selling anytime soon. All you care is to find a good price to buy, to slowly build your stream of income. I’m ok with that concept because I have money working for me since day one, and compounding ever since.
I’m also not worried about seeing my portfolio dropping in price. These companies are not worth 10%, 20%, 30% less because the stock dropped that much. This is the psychology barrier that needs to be broken: investors often think that a stock going up means all is well with the business, while a stock going down means the business has a problem. This is far from true. A lot of nervousness is also because many people don’t understand that stocks are pieces of companies, and they don’t know how to evaluate a business. They don’t know how to read a financial report, to determine quality. And they don’t know if a business is overvalued or undervalued. All they see is price. And price doesn’t reflect the value or health of a company.
As an investor, I remain 100% invested in equities, as the money machine keeps providing income. Even during recessions. Take any newspaper in 2008, or 2001, or the 70s, and notice how we had a lot of uncertainty, and how there were little to no hope. Good quality businesses continue to prosper – even if their stock prices didn’t reflect it immediately. They don’t have to. As businesses continue to react and adapt to challenges, they continue their journey to grow earnings, cash flow and dividends, and when you look at the rearview, deploying capital into these companies during challenging times was always a good decision. Sure, there will be mistakes along the road, not everyone could predict that Citi or AIG or GE would have such outcome, but that’s what a diversified portfolio is for.
No strategy can limit drawdown completely, so you didn’t fail if your portfolio is down. Successful investing is about managing risks, not avoiding it. Diversification, temperament, and patience for long term are the secret to build a resilient portfolio as a long term investing strategy.
For many years now I learnt how to shrug to these downturns. And the whole point as an investor is that there is nothing to be afraid of. Hence I’m always bullish, in every market. The DOW has continued to go up for the last 122 years with a few little bumps like the Great Depression and the financial crisis of 2008 along the way. And the Great Depression and the Financial Crisis of 2008 were really good times to buy stocks. Stocks were on sale during the Great Depression and the Financial Crisis of 2008. In fact, 1932, at the height of the Great Depression, was the best year to buy stocks in the past 122 years.
As I heard from another investor, the Fear Index truly puzzles me. What is there to be afraid of?
If the stock market goes up, you get richer.
If the stock market stays flat, you can still go to the bank to deposit your dividend checks.
If the stock market goes down a lot, you can buy more shares of your favorite stocks while they are on sale.
The stock market is a moveable feast, where there is always an opportunity to make money in the long run by buying quality companies at sound valuation. All we need is to separate the emotions that drives poor decisions when investing or trading: fear and greed.
“If you look at 1954, we were in a recession a good bit of that time. The recession started in July of ’53. Unemployment peaked in September of ’54. So until November of ’54 you hadn’t seen an uptick in the employment figure. And the unemployment figure more than doubled during that period. It was the best year there was for the market. So it’s a terrible mistake to look at what’s going on in the economy today and then decide whether to buy or sell stocks based on it. You should decide whether to buy or sell stocks based on how much you’re getting for your money, long-term value you’re getting for your money at any given time. And next week doesn’t make any difference because next week, next week is going to be a week further away. And the important thing is to have the right long-term outlook, evaluate the businesses you are buying. And then a terrible market or a terrible economy is your friend. I don’t care, in making a purchase of the Burlington Northern, I don’t care whether next week, or next month or even next year there is a big revival in car loadings or any of that sort of thing. A period like this gives me a chance to do things. It’s silly to wait.” – Warren Buffett at Buffett & Gates at Columbia Business School, November 2009.
Stay on course, Happy Investing and Happy Holidays!!