wheat vs. chaff

Let’s assume I’m correct that the bulk of the market downturn that began last November is behind us but that we’ll continue to be in a bear market, characterized mostly by an unusually high volatility, for several months. (We should all keep clearly in mind that this is an hypothesis and that the market generally acts in a way to make the greatest fools out of the largest number of people. So almost nothing is ever a “bet the farm” idea. But we have to start somewhere, and this is my best guess.)

One piece of evidence that we’re in this kind of market is the performance of stocks after reporting quarterly earnings. Companies that disappoint fall a lot, sometime losing a quarter or a third of their value, even though we can find ample evidence that this kind of earning outcome should have been anticipated. Companies with exceptionally strong results, on the other hand, are lucky to rise, say, 5%–and are as likely as not to give back a big chunk of that in the following few days.

My simple reading is that on bad news potential buyers disappear; on good news aggressive selling cuts short any gains.

What should we do while we wait for the market mood to shift?

My experience is that most people decide just not to look at their portfolios. I don’t regard this as the best course of action. But it takes a strong stomach to look at the damage that a long string of down days can do to holdings. And there’s a real danger of getting caught up in the highly emotionally-fueled collective panic selling that often marks the market bottom. So self-knowledge may tell you that, especially if your portfolio doesn’t deviate too much from the market, not getting caught up in the daily knife fight of bear market trading is the optimal strategy for you.

If you’re like me, and have substantially different holdings than the market, it’s important that you have a strategy that explains why you hold what you do and to monitor how and why the market is reacting to what you hold.

more tomorrow

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