Everybody’s first reaction to a period of falling markets is to pretend that nothing unusual is happening and not look at his/her portfolio. My experience is that “everybody” includes the majority of professional investors. There are, however, two measures we can take to strengthen our portfolios if we have the courage to analyse what has happened to our holdings during a volatile period like the past six trading days.
–gather information, and
–act to modify our portfolio structure.
Professionals have performance attribution software, which will calculate performance vs. an index plus a holding’s contribution to overall outperformers/underperformance for any/all of their stocks/funds over any period. I do the stock by stock performance calculation by hand and then rank the outperformers/underperformers by their impact on the portfolio, rather than trying to figure out exact performance contribution. I find that’s good enough.
What I look for:
Aggressive stocks will typically outperform on up days and underperform on down days. Defensive stocks should do the opposite. Performing in line with their character is no news. But stocks that outperform on both up and down days are. So, too, are dogs that underperform no matter what the daily market direction. I think there’s inevitably a message that the market is sending through such stocks. It’s well worth trying to figure out what that must be.
Time permitting, we should also look at representative stocks not in our portfolios to figure out the same thing. (Professionals also have this comparative information, for all the stocks in the index they’re competing against, available at the push of a button.)
Note: results for ETFs may be problematic, since a computer failure at BNY Mellon, which prices many ETFs for others, made NAV quotes for many unavailable last week.
The S&P 500 was down by 2.3% over the past six days. Although this is a short time, arguably a defensive portfolio should have done better than this, an aggressive one worse. If I think I’ve built a defensive structure and my portfolio is down by 6%, I should probably rethink what I’m doing. If my “aggressive” portfolio is down by 1%, I should be thanking my lucky stars–but also trying to figure out whether this is due to excellent stock picking or to poor construction. If I’ve accidentally assembled a collection of stocks that acts contrary to what I intended, I’ve probably got to at least ponder how to change it.
Early last week I tossed one long-term clunker in my portfolio overboard and replaced it with what I consider a better stock. For trades like this, I also ask myself how that’s turned out so far. Admittedly, a week is a very short period of time. But this will give me an idea whether I have a good feel for current market action or not.
I’ve often begun the process of analysis and reconstruction thinking that I should make my overall holdings either more aggressive or more defensive. Almost always, I end up making changes–but they’re virtually never the global ones I’ve intended. Instead of altering the direction of the ship, I find myself patching holes in the bottom of the boat instead. This usually improves the portfolio, and it prevents me from dong something crazy wrong during a period of stress.
My alterations tend to be one of two types:
–I trade out of stocks that are underperforming on both up and down days and into ones in the same general industry or thematic area that are performing in a healthier way, and
–I find that chronic clunkers become more visible to my eye in volatile times. (In my view, everyone’s portfolio has at least a few of these.) Because they’ve never gone up, they tend to have less downside than stars, whose owners have much more profit to take when they’re nervous. I find a time like this ideal to switch from the former to the latter. This ends up being most of what I do.
For me, the most difficult market transition to read in advance is the shift from a generally upward trend to a bear market, the garden variety of which can last for the better part of a year, and entail losses of, say, 20% in the S&P 500.
Typically, what induces a bear market is recession. I don’t think we’re in that market/economy situation today. If it were, patching leaks in the hull wouldn’t be enough. A change to a more defensive direction would be warranted.