It's been a wild ride lately. I think this two year chart of the
Russell 2000 Small Cap Index pretty much sums it up.
There are a lot of opinions being offered regarding the current
state of the U.S., European and global economy. I'm sure you've
heard many of them so I won't go into great detail here today.
The bottom line is that evidence suggests GDP growth is slowing,
despite government stimulus. And many governments, ours included,
are running out of options given their relatively high debt to GDP
levels and already low interest rate policies.
Yet corporate profits and liquidity remain very high, and in fact
many companies continue to beat analyst expectations. So while
governments may be struggling, many companies are doing quite well
- including the vast majority of our holdings in the
Small Cap Investor PRO
Until very recently things were ticking along quite steadily for
the stock market. Capital has a way of seeking out growth and with
low interest rates, stocks are extremely attractive. It doesn't
take a 'saver' long to realize that a ten year Treasury yielding
roughly the same as the S&P 500 - around 2.2 percent - is a raw
deal. That is of course, until stocks begin to tank...
So the markets, which represent the collective views of investors,
are trying to figure out where the world's economies will go from
here and how they'll deal with the reality that policy makers are
running out of ammunition. Capital also has to go somewhere, and
despite volatility, stocks are the most compelling option.
Personally, I'm a bit relieved to see that policy makers are
running out of options. Maybe we'll eventually get to a place where
markets actually decide how to allocate capital instead of
Washington DC. Wouldn't that be a welcome relief!
Dealing with Short-Term Market Volatility
I am a firm believer that the ever increasing complexity of
everything from policy and currency wars, to ETFs and high
frequency trading makes it exceedingly difficult for retail (and
for that matter most professional) investors to accurately predict
the short-term movements of the market.
This difficulty is especially true for small cap investors and is
best discussed with a specific example.
Below is a 10-day chart of a stock that I have been monitoring for
possible inclusion in our premium portfolio (note that I removed
the name). Over the last ten days this stock fell by as much as 36
percent and is now off around 13 percent - but what's more amazing
are the extreme swings in the stock's price intraday. Notice the
outlying orders that were completed between August 5 and August 10.
On August 5th, this stock jumped at the open, fell 10 percent,
bounced back to around $3.90 then consecutive jumps down culminated
in a single order around $3.10, or roughly 20 percent below the
day's high. The next day, August 9th, this stock appears to have
bottomed around $2.80 - that's 20 percent below the August 5 close
- in yet another volatile session.
For an investor that owns this stock, or was considering adding
shares to his portfolio, this type of price action is likely to
result in a groan or two - from feelings of either pain or missed
As I watch these types of price movements it's clear that an unwary
investor trying to tame this beast can get sucked in, ground up,
and spit out the other side both poorer and more confused than
So for most investors it's best not to get too caught up in the
market's daily fluctuations since - given the lack of news specific
to this security - fundamentals are clearly not driving price
action. Naturally, this is easier said than done and I'll admit to
more than a few hours over the past couple of weeks spent pulling
my hair and staring at my trading screen. After all, I'm only
But stock corrections are a process, not a single point in time,
and trying to be a hero at these times is usually fatal. Violent
corrections, like the one we have been experiencing, happen too
quickly for most investors to capture quick gains. Efforts to time
the yo-yo action of the correction leads to too much buying of
companies that will still go down, and too much selling of
positions that are likely to go up.
So it is all the more important that investors stick to a clear and
simple strategy during violent stock market gyrations and don't try
to get 'too cute'.
You may have your own strategy. Mine is to buy attractive growth
companies, at reasonable valuations, with significant exposure to
global growth trends. I'll take gains on some winners along the
way, cut some losers, and attempt to significantly outperform the
With this strategy guiding my decisions, the recent market action
is a time to average into more shares of my conviction positions
using limit orders. I can stick to this strategy because I'm not
investing money that I need to pay next month's mortgage, or to by
wood for the stove this winter. I'm an investor, not a trader.
If I need, or want, more capital, I'll sell those positions that I
have less conviction in - even if that requires taking a modest
loss - since I'd rather use the capital to buy a 'great deal'.
An Opportunistic Strategy for Periods of
My strategy doesn't mean I can't be opportunistic in a volatile
market - quite the opposite in fact. In the past I've advocated
using limit orders (as opposed to market orders) during periods of
extreme market volatility to try and average into your conviction
'buy and hold' positions.
Let's use the stock above as an example, and let's assume this is a
position you are confident in and want to buy more of - even if you
believe the stock market could sell off further.
Go ahead and enter a limit order, to expire that day, to purchase
shares at 20 percent below (you'll have to determine your own price
that seems 'too good to be true') the current market price. Then
walk away from the computer. Your order just might go through, and
if it does you'll have added to your conviction buy and hold
position at a heck of a discount.
I'll add that last week I did just this, increasing my holdings in
one position by around 60 percent on a day the stock dropped by 18
percent. I'm not expecting this stock to post immediate gains, but
over the next year or two I am confident this 'conviction buy' will
pay off. Like I said earlier, this isn't my firewood money so time
is on my side.
At other times certain stocks aren't moving too quickly to catch,
and they are just too attractive to pass on.
This was the case Thursday when a prior portfolio holding traded at
a depressed price for the third consecutive day. With the yield on
this stock above 12 percent, it was time to pull the trigger and
add it back to the portfolio.
What made this addition even better was that we had just sold it
for a nice 16.2 percent gain a week earlier. The opportunity to buy
it back for
20 percent less than our original cost basis
was just too good to pass on and highlighted what I perceived to be
a complete breakdown between share prices and fundamentals. I
expect this position will also pay off over the next year.
So the bottom line is this - while the market might be intimidating
when it's swinging all over the place, keep your cool. Don't try to
be a hero.
But at the same time if you have a strategy - and you should -
stick to it. Realize that these are the days you probably were
dreaming about for months - when your watch list stocks are selling
at 'too good to pass' prices.
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