Investors Should Focus More On The Plan, Less On The PivotSubmitted by Silverlight Asset Management, LLC on February 9th, 2018
This is the first in a two-part series on uncertain investing climates and how to navigate them.
Living in a real-time world takes a mental toll when markets are whipping around.
There are folks out there who caught wind their 401(k) fell a bunch on Monday. To become better informed, they may have watched CNBC’s Markets in Turmoil special that evening. Or perhaps they were up early Tuesday morning, and saw scary headlines about futures indicating a down open. Some sold down their exposure at the market open, and headed off to work.
The U.S. market indeed opened down. But then a funny thing happened… the market started to rally. A lot.
Below is an intraday chart of the S&P 500 from Monday through Wednesday. From the top-tick Monday to the bottom-tick Tuesday, the market declined 6.2%. Then, in just a half hour, it rallied 3.4%. Selling that open suddenly felt very painful!
The market is behaving like a hormonal teen fighting with a boyfriend/girlfriend. Little things become magnified at that stage of life—we’ve all been there.
Investors find themselves in a similar situation. Without rhyme or reason, the market is making big moves. Check your phone one minute, and the Dow is up hundreds of points. A few hours later, it’s down hundreds of points. It’s acting emotionally, not necessarily logically.
From early 2017 until recently, market sentiment was in a ‘puppy love’ sort of state. Risk assets across the board could do no wrong. U.S. stocks went the most days without a 5% correction since 1928.
Teenage breakups are usually precipitated by a series of arguments that escalate as each side notices more of the others’ flaws. Similarly, the end of a sentiment cycle is a process.
Several things likely contributed to the recent change in the market’s mood. In my view, breakdowns in the cryptocurrency market kick-started it. Not everyone who bought bitcoin near 20,000 necessarily sold equities as bitcoin losses mounted. Yet whether you own cryptos or not, a 50%-plus correction in an asset class garnering a lot of media coverage can make a subconscious imprint on risk appetite.
Soon after bitcoin began to tumble, attention shifted to mounting losses in bonds. Yields have steadily risen, and now reside at the highest levels since 2014.
The next domino to fall was entering a normal blackout period which prohibits companies from buying back their own stock. Share repurchases have been a key demand driver throughout this cycle, and there is a negative correlation between past blackout periods and market performance. Despite tougher sledding during such periods, dips have normally been bought before much damage was inflicted.
What’s different this time—and the real ‘straw that broke the camel’s’ back in my opinion—was a breach of key technical supports. Maybe turmoil in cryptos and bonds were just enough to stymie the “buy the dip crowd” from coming to the rescue. When they failed to hold the line, computers went haywire.
Trend following strategies have been increasingly popular this cycle. They likely contributed to the abnormally low volatility experienced last year. A lot of the day-to-day trading nowadays is computer-driven. Many algorithms are programmed to buy similar dip levels. When enough computers cooperate at similar levels, supports generally hold, and corrections prove shallow.
This week, we may be seeing the uglier side of the computer dominated trading environment. Pockets of flash crash behavior were evident around 3 pm EST on Monday. That may have resulted from widespread stop loss levels being simultaneously triggered. In other words, when ‘buy the dip’ didn’t work, many machines said: “No mas.” They flipped to capital preservation mode, causing a wave of selling pressure.
That’s how the market declines 6% intraday with no obvious news catalyst.
That also explains why the market can stop on a dime and rise 3% in under an hour, like it did Tuesday. Again—no obvious news catalyst. The difference between Monday and Tuesday was technical in nature—on Monday a key support was breached, on Tuesday a key one held.
The earnings outlook didn’t radically change. Interest rates didn’t make a huge move. Aliens didn’t land in Times Square. The main thing that changed was price. And price action itself can act as a catalyst, in the short run at least.
Over the long-term, however, prices follow fundamentals. Father of value investing, Benjamin Graham, advised that, “In the short run, the market is a voting machine, but in the long run it is a weighing machine.”
Most people are ill-equipped to compete with sophisticated computers trading intraday ranges.
Frustrating experiences, like selling the market open Tuesday, only to watch the market quickly rebound, illustrate why some people loath the stock market. But the market isn’t really the problem—their strategy is.
My broad advice for times like these is: focus on your plan, not your next pivot.
Planning emphasizes fundamentals. Pivoting emphasizes prices.
Planning is proactive. Pivoting is reactive.
Planning is an offensive mindset driven by clarity. Pivoting is a defensive mindset driven by fear of uncertainty.
Planning will make you more money over time with less stress. Pivoting often yields more stress, less profit.
If this all sounds great in theory, but you’re hungry for more specifics, I get it.
Next week, I’ll share three fundamental anchors you can count on whether the market waters are calm or stormy. These anchors are working now, and will likely continue to aid investors long into the future.
Originally published on RealClearMarkets. Reprinted with permission.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by Silverlight Asset Management LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by Silverlight Asset Management LLC, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.