The Fed Has Little Good News
The Fed’s Beige Book report on the US economy has just come out again. In it, business leaders report that the near-term outlooks is poor. The best that they can say is that the pace of decline in slowing. They don’t expect an upturn to start until the very end of 2009 or the beginning of 2010.
The extreme shrinkage in credit availability has made the present situation very hard for anyone to handicap. Given how awful the economy was in December and January, there’s no percentage for any commentator to say anything optimistic and risk looking foolish later. So the pessimism may be a bit overdone. Still, let’s take the Beige Book as roughly correct and guess that the recession will end in late December 2009.
Discounting Future Profits
In normal times, which these are not, the US stock market begins to factor next year’s expected profits into stock prices around June or July. We’ll probably be later than that this year. Typically, the markets begin to pick up on the possibility of an economic turn for the better about six months in advance, which the Beige Book says would mean around the end of June. If these two rules of thumb are correct, then we’ve got another several months at least to wait before we can see a sustained upturn on Wall Street.
While We Wait…
What can we do in the meantime? Most people, including professional investors, succumb to the temptation to hide under the bed and not look at their portfolios. That’s a mistake, because there are always useful stuff to do with your portfolio, even when you think your holdings are too ugly to think about. What do I mean?
An Investing Quiz
Let me start with a practical investment problem. Suppose you have a certain amount of money to invest. You buy a stock at $100 a share that you think can go to $120 in the next year. The stock drops to $90 instead, although you retain your conviction (hopefully supported by objective research) that the stock will rise to $120. You then uncover a second, comparable stock, again trading at $100, that you think, with equal conviction as stock #1, can go to $150 in the next year. What do you do? Think about this before you turn the page.
The correct answer, in my opinion, is that you sell stock #1 and use the money to buy stock #2.
Why? The main reason is that you’re holding a stock that you think can go up by 33%, but now have new information that has led you to a stock with similar characteristics that can go up 50%. So you should make the trade.
…Isn’t What Most People Say
This isn’t the answer most people give. What people usually say is that they’ll wait until stock #1 goes back to $100 and then buy stock #2. They say this because they can’t bring themselves to sell a stock at a loss, even if they stand to make money by doing so.
Intellectually, they understand the question–choose between making 33% or making 50%. They also know that what has happened in the past has little or no relevance to today’s decision. They may realize that for a taxable investor a realized loss can have a value in shielding realized gains from tax. But they’re so emotionally caught up in wanting the initial decision to be successful that they’re unable to act.
Two points, then:
*periodically taking out a clean sheet of paper and asking what your portfolio should look like now is always a useful thing to do, even in a brutal market like this one;
*for a taxable investor, realized losses can have a value.
Back to the title question: what can we do while we wait for a new bull market?
What You Should Do Now
First of all, don’t go crazy. The fact that everyone else may be running around like a chicken with its head cut off is no reason to join the crowd. Sit back, make yourself calm, turn off the streaming quotes and think about your long-term plans. Don’t do anything without considering it carefully. Remember, people always want to sell at the bottom and buy at the top, so what your emotions are screaming at you to do isn’t always the best thing.
In a perfect world, you have an investment or asset allocation plan that you have spent some time in preparing in calmer times. If so, you can take it out, review your goals and compare your asset allocation with the way your investments look now. If your goals haven’t changed, you’re fine. Given the sharp recent declines in the stock market, you probably have less in stocks than your target. You probably know much more today about your risk tolerances than you did two years ago. If you feel comfortable, reallocate. (The fact that the S&P now yields more than government bonds is another plus factor.)
If you don’t have a plan, you know now why you need one. You can get basic information from any discount broker’s website. Consider whether you can do this alone or whether you need professional advice.
Check the performance of your holdings. For individual stocks, this is pretty straightforward. You can call up charts on Yahoo Finance or Google Finance that compare the stock with an index like the S&P 500 to see how well they’ve done. (I think Yahoo charts are better.)
For mutual funds, you can do basically the same thing. Google gives Morningstar ratings; Yahoo shows a long history of performance, relative to an index and relative to other funds in a given category. Two mental adjustments to make: The figures showing performance will doubtless be correct. But the charts won’t be adjusted for the dividends on the S&P (say, 3%) or the distributions your funds make, typically in November or December. Returns for load funds, or ratings by firms like Morningstar, may be “load adjusted.” This is a complicated issue, but the bottom line is that the downward adjustment of returns for fund sales charges (loads) can be slightly greater than the charge you’ve actually paid.
Expect to have made mistakes. Wall Street is bad for the ego, even in the best of times. Don’t obsess about mistakes in 10%-20% of your portfolio if the rest is ok. But don’t just shrugg the mistakes off. Fix them!!!
If everything looks generally ok, you’re done.
Here’s More You Might Consider:
Think about upgrading your mutual fund holdings. If your review of your positions turns up a fund you own that’s a clunker–meaning it has done poorly against its peers in all sorts of different markets, or a fund you don’t own that’s a star, consider switching. Oddly enough, a time like this as a good time for a taxable investor to make a switch, since either your capital gain will be relatively small (hence, lower tax) or you will recognize a loss that can likely be used to offset other gains.
Stocks, too. In a panicky selloff like this one, the baby gets thrown out with the bathwater. Often toward the end of a downturn, even the highest-quality stocks are pummelled. If you bought a #2 company in an industry because you thought #1 was too expensive, chances are the value relationship is a lot more even now. If so, switch.
For a taxable investor, losses are assets, though not of the type you’d go out of your way to collect. It may be worthwhile to switch between even comparable companies to realize a tax loss. You may decide to switch back after the “wash sale” holding period is over, or maybe you’ll be just as happy with the new stock.
Suppose you have a real problem-child stock, one where the stock price seems to be telling you that the company may not survive the downturn. This is by far the toughest situation to deal with. If you’ve studied your typical investment behavior, you may know whether your instincts are sound in this situation or whether you tend to hope against hope and can never bring yourself to sell.
I think that if you want to continue to hold the stock, you have to satisfy yourself that the market’s fears are groundless. If you don’t know how, this is a sign that in this part of your portfolio you’re taking on too much risk. (At a bare minimum, you should look in an advisory service like the Value Line Investment Survey for financial strength ratings and both historical and estimated data on cash flow and debt. Look in the company’s annual report for its cash flow statement and the debt footnote, which will show amounts due in the coming years. You should also look for deterioration in the patterns of receivables and payables.)
You may be able to back into a decision if the position is very small, and you figure your time and effort would be better spent elsewhere. But at some point you should go back over how you wound up with this stock in your portfolio and resolve not to put yourself in this position again.