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Stocks are down today and you want to know why. We all do; the need to explain things is an innate characteristic of humans. A random walk down Wall Street doesn’t suffice. We want something more tangible, something in the news, something non-random.
There will be no shortage of explanations for today’s decline, ranging from a potential Greek default to China’s stock market collapse to a “technical glitch” that halted trading on the New York Stock Exchange.
For passive consumers of news, any of these rationales will serve their purpose (explaining the why) and are more or less harmless.
For investors, though, they can be quite harmful indeed. Why?
Because we are emotional beings and our impulsive response to bad news is to panic and sell after the fact. This would be bad enough on its own, but we also respond to good news and higher prices by panic buying (fear of missing out).
The S&P 500 is only down 4% from its recent all-time high (though it feels much worse because the S&P has been behaving like a risk-free CD). That pales in comparison to what we saw from 2000-02 (51% decline) and 2007-09 (57% decline). It also doesn’t yet measure up to the 18 previous corrections greater than 5% since the March 2009 low.
All of these corrections had fear-inducing explanations associated with them that seemed like the end of the world at the time. All were soon followed by new stock market highs.
That may or may not be the case this time around. It could be another run-of-the-mill correction or it could be the start of something bigger. We’ll only know in hindsight. Regardless of what happens next, reactionary buying and selling is not likely to be a successful investment strategy. If you can’t handle a 4% decline in stocks, you own too much equities. Lower the beta in your portfolio to your risk tolerance, to the point where you can sleep at night.
This is not to say that being more tactical, especially at this point in the cycle, is unwarranted. As I wrote on the six year anniversary of the bull market in March of this year, the next six years is not likely to mirror the last. This should favor more active strategies, particularly ones that focus on risk management.
It’s just that the execution of such a strategy should be systematic and unemotional. In plain English: you need a process to stand a chance. If you sell today, when do you buy back in and what is the catalyst for doing so? If you can’t answer that question with a repeatable process, stick to your investment plan. If you still feel the need to be more tactical, outsource it.
The news should play no role in how you manage your money because the news tells you what has happened, whereas investing is about anticipating what will happen. The time to think about and position for rising risk in markets is ex ante, not ex post. By the time the October 2002’s and March 2009’s come around, it’s too late.
Now back to your regularly scheduled program…
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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