It’s been a long time since stock prices have suffered a bludgeoning like the one we experienced in the fourth quarter of 2018. A whole new generation of investors and traders have never seen a market like this, where it seemed like there was no bottom. The great winter selloff of 2018 followed a massive run up in stocks that began in March of 2009, with the S&P 500 advancing around 330%, with only two meaningful pullbacks during 2011 and again during the 2015-2016 oil price-growth scare. Investors came to expect big gains every year, and added risk all they way up, as they are bound to do in Bull Markets.
And so, the Great Bull Market seems over, at least for now. Trade tensions with China, Federal Reserve interest rate policy, contracting corporate earnings, domestic political wackiness on a scale never before seen; all the troubles in the world finally caught up to soaring stock prices on October 3rd 2018. The S&P 500 lost around 20% from the October top, though many investor portfolios lost much more, overloaded on risk in the form of high momentum technology stocks.
When stock prices trend higher, there is liquidity, or a “nominal bid” to most stocks. A buyer, usually a trader, hedge fund or institution is willing to buy your shares at the prevailing price at any moment. When markets cave in as they did in 2018, that nominal buyer becomes a nominal seller, and lookout below; no liquidity and no bottom. For many short term-minded traders, stocks are only good if they are going up, and when stocks fall, traders that were eager buyers quickly become distressed sellers. This is how stock prices experience a free-fall.
For many investors, the 2018 stock market rout came as a shock, even though a big correction or Bear Market was inevitable. The classic investor play books written by Benjamin Graham tell us to gradually sell portions of winning positions on the way up, taking profits and securing gains. This sounds good, but in practice many people find it hard to do. Investors don’t like leaving money on the table when everyone else is enjoying a big run upward.
So what to do in a new environment where every rally is suspect, the background news sounds worse every day and confidence is shattered?
1-Avoid too much emotion: Investing in the market is just business. Keep your cool and look beyond the present moment. Avoid “recency bias”, the tendency to extrapolate the immediate past into the future.
2-Raise cash and earn interest while regaining your composure. In negative environments, winning is often best defined by not losing.
3-Look for opportunities in quality investments that have declined perhaps too much and develop a buy list. Quality holdings acquired at lower prices and kept long term have a good track record for building wealth.
4-Think in terms of a long term plan. Avoid playing the “Alpha” game of trying to outperform market indexes short term. Don’t chase short term bounces in prices.
Bear markets usually last from a few months to as much as three years, so be patient. Think in terms of this environment as an opportunity to clean house in your holdings and realign for the next Bull Market, which is sure to come and may be just over the horizon.