Insights & Advice

|

Fear and Loathing on Wall Street

It has been over a year since investors experienced the kind of sell-off that has beset the global stock markets this week. As of Thursday, most indexes have lost 10% or more. The jury is split on whether we are at the bottom or have more to go.

What to do when the bear is staring you in the face?

Most of the losses have occurred quickly, in around 8-9 days, which although painful, could be a blessing in disguise. Sharp, short corrections, in my opinion, are much better than corrections that drag on for months losing a little each day.

Of course, these large declines often trigger strong emotional reactions among investors but decisions based on panic rarely prove to be the right ones in hindsight. So I thought I would provide a little perspective on why the markets are selling off and whether or not you want to join the ranks of sellers.

Over the last few months the macroeconomic data began to weaken. At first, economists explained that it was caused by bad weather, then the Japan earthquake, but as the numbers continued to come in at a less than expected rates investors grew increasingly nervous. Then last week, while all eyes were focused on the debt ceiling crisis, the Commerce department announced that second quarter GDP came up short– 1.3% versus 1.7% expected. Even worse, the first quarter was revised downward to just 0.04%, a shockingly dismal performance.

That number, combined with an unemployment rate above 9%, plus continued uncertainty within the poorer countries of the EU, was enough to tip the scales. The trading range that the markets have been locked in since the end of April was finally resolved to the downside. Since then, we have broken several technical supports and are hovering just above a big one at 1,225 on the S&P 500 Index. If it breaks down and through this level, the chances of additional losses are quite high.

Sounds like doomsday, doesn’t it? Well, the same thing happened last year for the same reasons. The economy was slowing, unemployment rising, Europe was in trouble and the markets dropped 16% from April, 2010 through August. It was then that the Federal Reserve Bank announced the possibility of QE II. The markets reversed, exploded upward and investors never looked back.

Since March, 2009 we have had seven such “dips”. Each pullback was considered a buying opportunity and those investors that did so have been mightily rewarded. No one knows if this will be number eight or if we are going to continue lower.  At some level, stock prices will become just too cheap for value buyers to remain on the sidelines. Some say we are at that level now.     

My advice is to decide how much you are willing to lose and when you reach that limit sell and move to the sidelines. For some investors that can mean 5% (you should already be out), others will accept 10%, while some might be willing to sustain even more. Once your limit is reached don’t hesitate. Be prepared emotionally for the possibility that the markets could turn around a day after you sell out. Accept that if it happens, and don’t beat yourself up for not staying the course.

For those of you who have bond investments, keep them since bonds and gold are benefiting from the stock selloff.

Posted in A Few Dollars More, Portfolio Advice