Help! I Invested At The Market Top!

|
Includes: DIA, QQQ, SPY
by: The Struggling Millennial

Summary

2016 is off to a terrible start and market volatility is extreme.

Pundits are all over the map, some stating we are entering a recession and others encouraging investors to buy the dip before they miss out. What is an investor who.

Main Street investors typically get hurt worse during recessions for psychological reasons examined below.

Click to enlarge

The market has had a terrible start to 2016 with the Dow Jones Industrial Average (NYSEARCA:DIA), S&P 500 (NYSEARCA:SPY) and the NASDAQ (NASDAQ:QQQ) down -5.7%, -4.9% and -6.2% YTD, respectively.

Volatility in the market has been extreme. From Monday, January 4th, to Thursday, January 21st, the S&P 500 Volatility Index (VIX) was up 22.5% at close, reaching as high as 42% during Thursday's intraday trading. On Friday, January 22nd, the market saw a huge bounce and the VIX dropped -16.3% in a single day to close at 22.34, actually turning negative for the year. This market bounce will likely be short-lived as the relentless selling since the start of the year has triggered limit-orders and PUT's throughout the market. During every market crash there's a dead cat bounce, and during every market bull run there's profit-taking.

The DOW set an all-time intraday high of 18,351.36 on May 19, 2015. Since then, the market has mostly traded flat aside from the flash crash in August and the current retesting of those August flash-crash lows. The market is in "panic mode," and pundits all across the internet have a different opinion on what to do. There are plenty of reasons for why downward pressures are being exerted on the market right now. That is not the purpose of this article. The stocks, themselves, are falling in market price for one reason - investors are selling out of the market.

There are ways to make money in every market. Professional investors know this and will find ways to line their pockets in every bull market and every bear market. We are overwhelmingly NOT professional investors. Most of us are Average Joe's just trying to save a few dollars every week so we can one day retire and live a comfortable live in our golden years. It's the Average Joe's who get hurt the most during a market crash because we tend to come in late to the party, panic after the damage is done, sell due to fear at the bottom, then once the dust settles and our confidence in the market starts to recover, buy in at much higher prices. There is a whirlwind of news stories covering the market volatility, and every pundit has something different to say.

Do we join the party and sell it all despite being 12.3% off all-time highs in expectation for things to get far worse?

Do we hold on with our tails between our legs and see how this all shakes out, potentially missing an opportunity to strike while prices are at rock bottom?

Is it time for us to Shop Till We Drop, even though the S&P 500 still trades with a P/E of 20.1x, significantly higher than the 15x historical average, taking a risk that stock prices could plummet even further?

Forget the market pundits that have seven, eight, nine, ten and eleven-figure portfolios. What's Average Joe with a net worth of five or six figures supposed to do as he watches his net worth cut to a fraction of what it was mere months ago?

Memories Of The Financial Crisis Still Haunt Us

I'll never forget where I was when I heard Bear Stearns collapsed. I was in the waiting room at the doctor's office waiting to get an annual check-up. It was 2008 and I was in the middle of college. I didn't even know what Bear Stearns was, I just remember watching the talking heads on TV going nuts over the whole thing. It was the most-often touted trigger of the Financial Collapse, and by February 2009, the market was trading at less than half of what it was back in late 2007.

I watched friends and family members weep over their portfolios, several of them I recall selling a lot of stock at the worst possible time. I remember blame being placed on their financial advisors, as if the advisors had any control over the major market indices. Very few analysts saw the collapse coming. It still really bothers me thinking about those years because there was no bigger financial mistake someone could have made than selling their portfolio during the collapse.

Yet this is how history has played out time and time again in every downturn. Just look at the recent pa.

We had the tech crash of 1999-2000.

We had the financial collapse of 2008-2009.

Two of the greatest market collapses in US history all happened within a decade of each other. It has created this perception in the back of investor's minds that every recession will be met with a 50-60% dive in major market indices. This just isn't true - typical recessions are on the order of 20-30% and are totally normal - as bull markets persist, investors get overzealous and start paying too high of a multiple for earnings. Things eventually have to correct themselves. The Fed's monetary policy has helped encourage borrowing, thereby injecting more money into the system and creating more prevalent multiple expansion, so we can anticipate bubbles to occur more and more often. Likewise, earnings cannot always present stable, consistent, metered YoY growth and there must be a pull-back eventually. It's all logical and understandable. And it is normal.

I feel that this bull market has never been fully trusted, and investors have been seemingly waiting for the other shoe to drop for quite some time. I don't think we have ever "mentally" recovered from the previous two crashes, and it shows in the panic we see today.

What Is My Point In All Of This?

Let me pose a simple question:

On May 19, 2015, you own 1,000 shares of Johnson & Johnson (NYSE:JNJ) @ $103.96/share.

On January 22, 2016, you own 1,000 shares of Johnson & Johnson @ $96.75/share.

How much Johnson & Johnson do you own?

The answer is you own 1,000 shares of Johnson & Johnson.

My point is not to worry. You still own the same piece of the same company that is still pumping out billions in profits. All that changed is the current auction price. Every market fluctuates in price.

  • Your home fluctuates in price every day. Are you going to sell your home because the market value dropped 6.9% in an 8-month period?
  • What about a family-owned business that has been around for generations? If profits are down 6.9% in a random 8-month period even though business is still good, are you going to sell the business that's been in your family for generations?

If your answer is, "NO!" to both of those questions, then why would you do the same to your ownership stake in Johnson & Johnson?

People behave rationally with their home. People behave rationally with their family business. But something changes when it comes to stock ownership. Because market prices are constantly updated in real-time and investors have down-to-the second access of their company's present value, something transforms in investor's minds and they become nervous, irrational and emotional. They forget that their ownership of stock is the same as owning a piece of their family business. It represents a real share in the company's earnings. Perhaps it's because so many people feel cold and disconnected from the businesses they invest their capital in because they don't show up to work every day and they don't see the living, breathing operations. If this is how you behave, maybe you should abandon investing in stocks.

Growth is not linear. The market is cyclical and is prone to booms and busts. If we are entering a bust, it's not a serious problem for your portfolio because a boom is right around the corner. It is only a problem if you SELL during the bust. If you wouldn't sell your family business because of a down quarter or a down year, and you wouldn't sell your home because the present housing values in America dropped YoY, you shouldn't be selling your stocks for the same reason. As long as the fundamental earning power of the companies you are invested in are sound, that is all that should matter and time will correct short-term market price fluctuations.

So What Should I Do?

Investing is not an exact science, so there are no "right or wrong" answers, at least in the short-term. I can tell you what I would do - and what I am actively doing - given the current economic situation.

  1. First, do nothing. Sit back, relax and take a deep breath. Have a glass of wine and watch a movie. Good decisions are rarely made out of haste and panic.
  2. Examine the most recent SEC filings of the companies are you are invested in. The goal will be to determine if the financial engines that generate earnings for your investments are still sound. Most stocks that make up the S&P 500 are seeing their market prices fall due to multiple contraction. Many S&P 500 companies are experiencing negative earnings growth, but it is often due to indirect headwinds - a strengthening US dollar lowering reported EPS, a slowing global economy (particularly China) that is negatively impacting revenues, the drop in commodities causing big hits to margins, etc. These situations do not reflect negatively on the companies themselves. Their earnings machines are still intact, but market prices are dropping due to rampant investor speculation. If you are a prudent, conservative investor like myself, chances are your companies are victims of the above scenario. If you are invested in risky, small cap E&P oil companies or speculative small cap biotech companies, for example, your story may be different. You must do your job as in investor to analyze the numbers.

    Determine all the stocks you own that are still viable investments for the future (which, if you did your homework while buying, should be nearly all of them, if not a full 100%). Sell only if you feel the long-term earnings machines are fundamentally damaged.

  3. Reinvest all dividends. This should be a no-brainer as long as you can afford to live without taking them as income. Reinvesting your dividends while market prices decline will help lower your average cost in ownership. There are several stocks I own that show paper losses, and I am taking this opportunity to lower my overall cost in anticipation that when I retire in three decades it will not matter.
  4. Buy on the way down. Like #3 above, we are trying to lower our average cost. If you were happy buying the DOW at 18,351.36, you should be thrilled to get the same collection of companies in the 15,XXX's! Right? This is another phenomenon I have difficulty understanding - how can an investor be happy paying top dollar when positive speculation is pushing prices higher, but apprehensive to buy the same collection of companies at a fraction of the price because rampant negative speculation is driving the prices lower? Now is the time to capitalize on purchasing quality companies, not run and hide.
  5. Be patient and trust that time will heal all wounds. You may see huge losses on today's purchases tomorrow. Those losses may persist 6 months, 1 year, 2 years or 3 years from now. But in a decade, you will probably be glad you did what you did and were patient and disciplined enough to grin and bear the meaningless paper losses.

That's really all there is to it, ladies and gentlemen. It sounds easy and overly simplistic, but that's what my investment strategy is. I'm not smart enough to time the market, so I'm just going to periodically buy in and trust that time will work out the kinks for me. Since prices are declining, I'm just becoming more aggressive with my purchasing.

You may be thinking, "You're 29 years old. You have plenty of years ahead of you for time to work out your mistakes. I'm retired and need income now."

That may be true if you're the type of retiree that plans on deducting a percentage from your portfolio's principal every year and hope your nest egg outlives you. That is a risky play in my opinion because my goal is to never sell the stocks I purchase today. My goal is to structure my portfolio to live off of the dividend checks one day without ever selling principal. If you notice, while the DOW, S&P 500 and NASDAQ's market capitalization is declining, the dividends are not being cut. Sure, it's possible a few companies will freeze, reduce or even eliminate the dividend, but in a diversified portfolio, dividends are far more stable than market prices. It is not too late to structure your portfolio in this type of manner. (Of course, always consult a financial advisor before doing so because the tax consequences could be huge.) That is my plan and I'm sticking to it.

Disclosure: I am/we are long DIA, SPY, QQQ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: All information found herein, including any ideas, opinions, views, predictions, commentaries, forecasts, suggestions or stock picks, expressed or implied, are for informational, entertainment or educational purposes only and should not be construed as personal investment advice. I am not a licensed investment adviser.