Coping with Panics, and is the Market Cheap Enough?

I may be a day late to comment on stock market panics as the UK market bounced back today (25/8/2015) after sharp falls in the previous few days. But I had the chance to reflect on recent events after a trip to the somewhat stormy Rensburg AIM VCT AGM. It seemed pretty obvious to me that the markets worldwide were being driven by fear and emotion on the whole. Explanations given were both numerous and dubious such as the collapse of the Chinese stock market driven by retail investor sales, the slowing of the Chinese economy, that impacting on commodity prices generally, the collapse in the oil/gas price due to a glut of those products from more production while demand is falling, and the possible end to the long running bull market. Some of these might have an impact on some companies, but share prices are falling across the board which tells you that investors are selling holdings regardless. And lower energy prices should boost many companies and whole economies so not all the news is negative.

The stock market is one of the few markets where buyers don’t welcome falling prices. If you went into your local supermarket and found prices lower than the day before, would you not buy more? But there are numerous “trend followers” in the market because “momentum investing” has been shown to work both when prices are going up and going down. Once a minor trend has developed, it’s self perpetuating, compounded by the influence of index tracking funds and “closet trackers”. Redemptions by inexperienced and panicked retail investors in funds also generate sales of stocks even when the fundamentals of companies held by a fund have not changed.

As a retail investor who invests in individual stocks, can I suggest all you should be doing is looking at the fundamentals and outlook for those stocks and ignoring short term market trends. Therefore you should welcome price falls. Indeed if they become cheap you should buy, and if they become cheaper than when you bought them, when presumably you justified the valuation, you should buy more, assuming the financial fundamentals and prospects have not changed.

That presumes you have some spare cash, so it’s always worth having some cash in your portfolio to exploit such circumstances. At the start of an obvious panic, it can perhaps be worthwhile liquidating some of your least favourite or losing stocks which is always a good thing to do anyway. This frees up some cash for exploiting later buying opportunities when the market falls further. This is part of the “sell the losers – buy the winners” strategy which many experienced investors have learned to use. It’s a strategy that ensures you don’t get too emotionally involved with stocks but rebalance your portfolio to ensure you are buying successful companies and removing the duds.

Note that I am not suggesting that market trends should be ignored altogether. Medium to long term trends are different to short panics. And trends in individual stocks can be helpful to follow. But when most of your holdings are all falling as buyers have simply left the market because some Chinese investors are in a blue funk (compounded in recent events by it being an August holiday period), then I suggest that you need to think a bit differently.

In essence, if you were happy with the valuations of your investments a few days or weeks ago, is there any great reason to change your mind? Perhaps on commodity related stocks but they have been in a bloodbath for many months.

These are of course my personal opinions. But I am looking forward to the market becoming cheaper when I can pick up more of the stocks I like at better prices. So the answer to the question “is the market cheap enough” is no as I always prefer it cheaper, but it might be getting there.

Roger Lawson

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