How to take advantage of falling markets

published 12 February 2018

180212-markets-b — US stocks are still overpriced

Is that it?

The US market managed to rebound on Friday after a fraught session stuffed with highs and lows. By the end of play, the S&P 500 closed up 1.5% for the day, and the Dow Jones and Nasdaq both managed 1.4%.

Have we seen the bottom for this panic? Or the top of the market for this cycle?

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Here's the honest answer it doesn't matter...

The US market is still expensive don't waste time worrying about anything else

If you're fretting over the gyrations in the US market, here's a calming word: don't.

It doesn't matter if the US market has hit the top or not. It really doesn't.

Don't get me wrong. From a curiosity point of view, I'm interested to see if we have actually seen the top already, and if this is just a rebound before another dip lower.

Opinion seems divided among various commentators whose views I respect, but it rather boils down to "was that the parabolic move (or market blow-off top' or melt-up') that we've been waiting for? Or is there a bigger one to come?"

In other words, the consensus is actually pretty clear: we're in the end game. The only real question is: have we seen the top already, or is there one last blast of mania left in the market?

For what it's worth, my gut feeling is that there's one last blast. But that could easily be wrong. Depending on economic data and Federal Reserve comments from here say inflation figures let up for a little while, or the Fed hints at being careful with further interest rate rises we could easily see a new spurt of enthusiasm for stocks.

And as I pointed out on Thursday last week, stockmarkets can be impressively slow on the uptake.

But in any case, from a practical point of view, it's not that relevant.

One thing that we already know about the US market is that it is still very expensive. So should last week's 5% drop change our minds about the US market, if we'd already decided to avoid it because it's expensive? The answer, clearly, is "no". This particular drop doesn't change anything.

At some point, the market as a whole will be cheap enough to be considered a "buy" again. But we're not there yet.

You have a plan, don't you?

So what does that mean for your portfolio?

The problem with times like these is that it makes you feel desperate to "do something". When the market moves a lot, you feel that there should be profits there to be had.

That's the danger of consuming too much financial news. These are short-term moves. You invest for the long term, and you make your money over the long term. When you act with short-term motivation in mind, you will almost certainly lose money.

"But if I buy the dip now, I can make a quick 10% on my money on the turnaround trade". Well, maybe. Or you could lose another 10% as you try to pick the exact right moment to get in.

And when you fail, you'll add more money to your trade, in order to get back to even. And when that fails too, you'll give up in disgust. Then the market will bounce back. And that will add rage to the emotional stewpot, and you'll end up making more stupid mistakes.

The point is, you should already have a plan. Does this fall in the market change anything about that plan?

Does it change the fact that given you have another 20 years until retirement, you broadly want most of your money to be in equities, and you've already picked out the cheapest markets or most attractive funds you could find?

Does it change the fact that you have ten high-quality stocks on your watchlist, and you've been waiting for the opportunity to buy them at a more advantageous price?

Today should not be the day that you are suddenly looking at your portfolio and wondering what everything is doing there. You shouldn't be waking up this morning and realising that the fund with the elaborate name that you can't quite remember buying was leveraged to the hilt in short Vix contracts and has now fallen in value by half.

Today should not be the day that you are looking at a stock for the first time, thinking "that's got a 7% dividend yield now", and pressing buy' because you are worried that the opportunity' will go past you.

Preparing yourself during the calm, dull days of the market will prevent you from making big mistakes and will allow you to take advantage of opportunities during the volatile, exciting days.

If you have your plan and you have your watchlist, you're fine. Sit tight and wait for prices to come to you.

And if you don't have a plan and you don't have a watchlist (assuming you're even that interested in being an active investor), then start working on one. And don't hit "buy" or "sell" until you've done it.

Remember the worst thing you can do in markets is destroy your capital by making unnecessary mistakes. So if you're feeling jittery and unprepared, take a deep breath, step away from the screen, and schedule some time to review your portfolio and do some research.

You don't have to do anything today. There is always a next time.

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.