I’ve just wrote a post-Thanksgiving update to Current Market Tactics. If you’re on the blog, you can also click the tab at the top of the page.
concrete signs of slowdown are emerging
A few days ago, Rio Tinto, the giant Melbourne/London mining conglomerate, said some Western customers (European?) are asking the company to delay shipment of contracted amounts of industrial metals (how this works financially is an interesting, semi-complex topic, but irrelevant here) . FedEx announced this week that orders for airfreight shipment to the US, the EU and Japan are losing momentum as customers opt for slower and cheaper ways of getting their products into retail outlets.
In other words, for the first time in two years +, some firms are beginning to worry about having too much inventory and to work it down. In one sense, this isn’t good. But it had to happen eventually. And the equity markets have been discounting this development since July. After all, FDX has lost a third of its value in the past three months; RIO has been clipped by 37% over the same span.
So this is not really news. And as FDX said, customers’ hair isn’t on fire. They’re just being a little cautious.
the real problem is in the EU
There, a modern version of the Iliad, sans Helen, seems to be playing out, with France and Germany taking the role of Troy and, well …Greece in the role of Greece.
In a nutshell: the EU let Greece in about a decade ago, even though it didn’t really qualify, giving it unrestricted access to EU credit. Greece promptly borrowed (and spent) a gazillion times what it could ever repay, funded ultimately by the ever hapless financial institutions of Germany and France. Greece says it’s sorry and will change its ways–but is actually doing very little. It seems instead to be milking the situation for the best possible terms for default, or perhaps just for more time at the EU credit trough–which, I guess, is what almost anyone would do in their situation.
On the other hand, German politicians are on the horns of a dilemma. They either fund a Greek bailout, in which case they’re tossed out of office, or they let Greece default and destroy their banks. And they’ll be thrown out of office again. So they don’t want to act, either. Arguably, this is also their best strategy (short of actually doing their jobs and fixing things).
Having endured this stalemate for about a year, the nerve of European investors seems to me to have finally cracked. They’re selling anything not nailed down in a classic panic. The rest of the world is being dragged along for the ride.
If there’s silver lining to this, financial market panic may provide the political cover the EU needs to stop procrastinating and begin to act.
three stock market scenarios
I’ve sketched this out in a little more detail in Current Market Tactics this month and last.
I have three targets for the S&P over the coming year, depending on economic circumstances:
nothing wrong (hah!) 1350
muddling through 1170
recession ahead 1000.
I still think that muddling through is by far the most likely outcome. If so, 1170 would be the central tendency around which Wall Street will revolve. Panic aside, if an investor thought he would need a 7% return in order to be induced to take the risk of owning stocks, then he should be a buyer at an index level of 1090. That’s about 3.5% below yesterday’s close. Below that any selling, which I already regard as overdone, would enter into another, higher, level of craziness.
The main item on our wish list should be market stabilization.
what to do
My thoughts haven’t changed very much.
When we get to the other side of the current storm, I think the winners will be firms with Asian exposure, participants in technology-based change and companies that serve the affluent. At some point it will be right to trade your TIF in for WMT (I own the first but not the second), but not anytime soon.
If you can force yourself to get out from under your desk and witness the carnage, look for ways to upgrade your portfolio. When selling starts, it may be rational at first and the weakest stocks get sold off first. But then the selling often takes on a life of its own. When panic sets in and the bad-stock ammunition runs out, good stocks get thrown out the window at crazy prices as well. Why? That’s all that’s left to sell. No other reason.
My stocks got really whacked on Thursday, so I guess I’ve got to think that we’ve entered the latter phase.
Under the desk (or the bed) is sooo much more comfortable at a time like this, but my experience is that you’ve got to force yourself to at least analyze what’s going on.
If you can’t do this, or if you know you’d just do things you’d regret later–and you know your psychological makeup better than I do–find a good book.
By the way, in my view the current selling has nothing to do with year-end mutual fund housecleaning.
I want to add something about the discounting mechanism, but I’ll save that for Sunday.
frozen by the screen
Every seasoned professional investor I’ve sat down and compared notes about the profession with has experienced this phenomenon. Usually it happens when the market is declining and you’re underperforming–sometimes badly. You turn on your computer or your trading machine to see what prices are doing. Your stocks are doing poorly again. But instead of either turning to another page or going back to work, you sit and watch the flow of trading in your stocks and worry. You may be mesmerized or horrified. You’re using up a lot of emotional energy. You know this isn’t helpful, but you just sit and watch–and maybe perspire heavily. You can’t tear your eyes away from the screen.
This isn’t good. For one thing, you’re not doing anything productive. You’re not thinking about how you can tweak your holdings to achieve even higher levels of outperformance. In a deeper sense, though, this behavior is a sign that you’re either about to lose your confidence or have lost it already. You’re focusing on failure, not success.
This happens to every professional now and again. It’s the equivalent of a hitter going up to the plate worrying about being hit by a hundred mile an hour fastball and breaking his ribs, rather than visualizing how he’s going to hit a double off an accomplished pitcher. You’re setting yourself up for failure.And the cold reality is that if you can’t get into a positive frame of mind, then you may not be cut out for this line of work.
For a portfolio manager, there are several obvious steps to take to restore a positive mood:
1. Turn off the price screen and don’t turn it back on.
2. Take out your analysis of the stocks you hold that are performing the worst, rethink and rework your assumptions, and come to some conclusion. The result will probably be that you believe the stock is as cheap as you thought. Even if you spot some fatal flaw, you’ll have some reason other than fear for making a change.
3. Rethink your portfolio structure and whether it’s still appropriate.
4. Look for depressed stocks that you always wanted to own but thought they were too expensive. Consider whether a market downdraft has made them more attractive.
5. Look for long-term weak performers in your present portfolio (you know they must be there, because everyone has them). They’re probably not going down much (because they never went up). Think about using them as a source of funds for any new additions.
6. You can always take some risk out of the portfolio by making it look more like the index. In my case, however, every time I’d done this it’s been a mistake.
7. If you’re going to do something stupid, like selling a perfectly good stock while its price is down, do it in a very small amount.
8. If nothing else works, go to the gym …or read a book. Just don’t turn the screen back on.
Of course, there’s an underlying assumption I’m making–that what’s going on is a moment of mental weakness, a temporary loss of focus. It’s also at least possible that your unconscious is telling you that you have deep fundamental flaws in your portfolio that you need to fix as fast as possible. But if you know yourself well enough psychologically, you should be able to tell the difference.
for regular people investing their own money
Funnily enough, these are much harder cases to diagnose. Good professional investors are highly trained in what is an often counter-intuitive way of thinking about the world. So the pitfalls they encounter are usually well understood, because they’re the ones every other manager has encountered as he tries to master his craft.
For regular investors experiencing angst at declines in their holdings, I’d have three basic questions:
1. Do you know how the companies whose stocks you hold earn their money? Have you read quarterly/annual reports and 10Q/10K filings? Have you formed an expectation about potential returns for each holding? If you haven’t, you’re not investing, you’re buying lottery tickets.
2. Do you have an overall financial planning strategy? Is the risk in the stocks you hold appropriate for your economic circumstances?
3. Are you willing to devote the time needed to develop investing skills, or would you be better off finding a financial planner to help? (Finding a competent adviser is a whole other can of worms, however.)
why am I writing this today?
My personal stock portfolio had been holding up relatively well during the correction–until yesterday. I did end the day with two green lights on the screen, DKS (who knows why) and 1128:hk, where the market was closed while New York was falling sharply. But my other stocks really got clunked. That’s just life. But I noticed that I was starting to stare at my screen in an unhealthy fashion. So I ran for about a half-hour and read a couple of chapters in a book about web design.
For what it’s worth, my take on the sharp reversal in my portfolio’s relative fortune signals that the correction has entered a new phase. The tendency in downdrafts in the market is for investors to begin by selling stocks they don’t care much about. As the correction progresses, the selling reaches closer and closer to what people consider their crown jewels. If the decline ends in a mini-panic, even parts of core holdings get shown to the door. I’m not saying this last happened yesterday, but I do think the correction took another step closer to completion.