Five Keys for Deciding What to Do in This Stock Market – Buy, Sell or Wait?

Saturday, May 22, 2010

In Thursday morning’s write-up, I said I would next discuss stock valuations. However, with Thursday’s sizable market drop, I decided to spend the time analyzing portfolios and holdings. As a result, I did a bit of client buying on Friday. So, instead of valuations, I thought this article should be about dealing with periods such as this. When widespread discomfort and uncertainty cause significant price declines, what is a wise investment strategy?

When mentoring those starting out in the investment business, I remind them that the excitement that draws people in also has a dark side. Just when it seems we have achieved a semblance of understanding and control, the unexpected can suddenly take center stage. And there is nothing as “exciting” as a fear-driven sell-off in the stock market.

So, how do we deal with such situations? How do we keep our cool while others run around in a panic? And, most importantly, how do we conduct a wise investment strategy during such times?

  1. Dismiss paranoiac and catastrophic visions. In economics and investments, most troubles are rooted in human actions, and, when painful enough, humans act to remedy the problems. The same goes for natural disasters, and we have a history of dealing with most types. Dismal forecasts are simplistic extensions of downward sloping trend lines, with no consideration of positive, counteractive forces.
  2. Don’t try to catch the bottom. Those who buy at the low (and afterwards are lauded by the media for their prescience) are mainly lucky. The action is the result of either pure happenstance or being fortunate to have hit on a rationale to buy at just the right time (I discussed this in “Beware False Prophets Bearing Profits” – May 17). Wise investment managers often buy early because panicky sell-offs get disconnected from logic and reality, making bottoms hard to forecast. Such a drop finally ends when sellers cease to sell and/or buyers decide not to wait any longer.
  3. Realize a decision has to be made during this period – buy, sell or do nothing. In investing, doing nothing is a decision – whether made intentionally or not. Do-nothing “actions” often pay off in “would’a, could’a, should’a” losses – and they are every bit as painful as trying to pick out a good stock and then watching it go down. Doing nothing while waiting for something to flash “BUY!” at the bottom will likely result in hearing a deafening “SELL!” at just the wrong time. We often hear and read the words, “Wait until the dust settles.” At the time, it can seem like wise advice, but it is the equivalent of trying to look smart while avoiding making a decision.
  4. Stockholders have time working for them – for sidelined investors, it works against them. If you have chosen a well-run company in a solid industry, then good things should eventually happen. Yes, the path to stock price gains can get waylaid by any number of factors, but that company’s strengths will eventually shine through carrying the stock price along.
  5. Low (attractive) stock prices for well-run companies occur when investors are worried or are looking elsewhere. Likewise, high (unattractive) stock prices occur when investors are confident and are focused on the companies. Obviously, then, accomplishing the goal of “buy low, sell high” means acting in a contrary manner. This approach is the most challenging for all investors, but can also be the most rewarding.

So… Strive to buy good, long-term investments during worrisome times. A well-reasoned buy establishes a position that should provide a good future return – even if the price drops the next day, week or month. It’s far better to take on positions in a seemingly bottomless market than to jump into a supposedly easy money one.

Note about buy-and-hold: I know buy-and-hold strategies are dismissed nowadays. Weak, volatile stock markets often convert many investors to traders. And, for a while as the market see-saws, the traders’ short-term gains can look compelling – particularly against the long-term holders’ sideways performance. Then it happens – the economy regains its footing and the leading companies, having taken advantage of the weaker period to solidify their strengths, take off on a multi-year run. Eventually, the traders, who closed out their “profitable” positions at lower prices, play a game of chase, finally becoming buy-and-hold investors again.

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