4 Rules For Investing In Bearish Sentiment Times

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We are living The levels of anxiety is trending upwards.

There are many signals that a pullback is about to come soon.

This is the time to be focused and ready for opportunities as they come along.

The British politician Joseph Chamberlain might be mostly recalled based on the statement he made back in the year 1898:

"I think that you will all agree that we are living in most interesting times. I never remember myself a time in which our history was so full, in which day by day brought us new objects of interest, and, let me say also, new objects for anxiety".

The second half of June 2016 is keeping to this statement and indeed it is getting more interesting day by day.

I am sure that only a handful of people were surprised that the FED committee decided to leave the Interest rate flat. The recent employment report which was so pale alongside the unemployment claims report which exceeded the analysts' estimations could easily lead to the conclusion that a hike is not relevant at this point.

When looking at the next graph taken from tradingeconomics.com which captures the U.S labor force participation since the beginning of the century there is a clear trend of constant drop in the level of participation from the high levels of 66-67% to the bottom of 62-63%.

A short term change in this trend was seen back in March'16 but it turned back again in the following months and ended up in May at 62.6%. If this trend continue it could mean an extra vector that the FED should worry about and take into account in its models.

The inflation rate is signaling weakness as well. Only yesterday the U.S. Consumer Price Index (NYSEARCA:CPI) was announced at 0.2% versus an expected 0.3%. The prices remain low as commodities' prices have hard time to recuperate.

As all signs are signaling that U.S. economy is still soft I wouldn't be surprised if the next Interest hike this year, if any, would take place post the presidential elections in November.

More unknowns are expected to come from the other side of the Atlantic Ocean. The Brexit decision would take place next week and any decision would not be considered a surprise.

Still, a decision to leave holds the potential to ignite an economical hearth quack. Based on X-rates.com The British Pound fell substantially compared to the EURO during the recent months.

Based on the BBC the UK housing prices, which were hiking consistently during the recent five years, have slowed down in 2016 and naturally would be impacted by the Brexit decision. A bubble burst in this front, followed by or driven by a slower U.K. economy due to extreme changes in business condition between the U.K and the rest of Europe could be catastrophic to both the U.K. economy as well as to the global economy.

As the number of unknowns is growing the fluctuations in the markets are growing as well. As an example the S&P 500 volatility index (^VIX) exceeded 20 points on Wednesday.

The next VIX graph is demonstrating how important is this 20 points bar at least during the recent year.

This bar was the first sign for a significant market correction. It indeed true and with all above uncertainties we could face another 5-10% pullback in the market very soon.

What should an investor do?

During these interesting times of high volatility there is a risk that investors would make mistakes due to the overall negative sentiment and emotions that couple together with the global anxiety. If played right this negative sentiment in the markets can deliver great opportunities that one might skip if he would focus only on the downside.

Especially during these days, it is important for the long term investor to stick to his plan and to his investing rules.

Here are my top 4 golden rules:

1. Don't chase yields: high yields paying stocks might be exciting in the short term but value destroys in the long run. As I am looking for healthy companies, with great and prosperous future, I would need to make sure that the management is not handing out too much of the generated cash. Instead I prefer to see it reinvesting its cash back in the business for future growth.

The initial indicator to signal a problem in this front is the Payout ratio of the dividend per share out of the quarterly EPS, but a routine deep dive analysis into the quarterly Earnings reports is required as well.

2. Diversification among companies and sectors: While the overall sentiment in the market might be negative there could be some sectors that would actually perform positively and outperform the markets due to specific tailwinds.

Diversification allows you to reduceunsystematic risks that are built into every investing vehicle, stock or a sector ETF.

The next graph compares the behavior of the S&P500 index, represented by the SPDR S&P 500 Trust ETF (SPY) and the REIT sector, represented by Vanguard REIT Index ETF (VNQ).

Last month the S&P500 almost reached its all-times-high levels but redrew afterwards by 3-4%. The REIT on the other hand, enjoying the tailwind of the low interest rates maintained its positive trend in the recent four months. By diversifying among different sectors the risk of a specific one is weakened.

3. Look for strength and success: in each sectors there are companies that are the king of the hill, the moats that have a long successful history and have proved their ability not only to survive times of crisis but also come out of it even stronger than before. These are the companies that I am looking for. I prefer to have a relatively lower return but with the recognition that my holdings in this company would serve me well for a long period of time.

Two of my favorites are Johnson & Johnson (JNJ) and AT&T Inc. (T). Both companies have been around for decades. Both had to reshape their strategies and reinvent itself to adjust to the everlasting changing competitive landscape and technologies. The investors that set back and held these companies in their portfolios have really enjoyed the ride.

4. Take actions during times of anxiety: psychology is one of the dominant players behind the scene of the stock market. The ability to take risk during the time of high anxiety allows the investor to take actions in comfortable buy prices.

Like in any type of negotiation, when the seller is too stressed the buyer would be able to close the deal at a better optimized price. The same thing works in the stock markets and these are exactly the days to pay close attention.

One recent example from my portfolio was the purchase of Schwab U.S. Dividend Equity ETF (SCHD) which I have written in more details here. The balance between risk and reward seemed to be tending towards the reward at the time, especially with the ETF that is well diversified with great holdings.

Taking an action during a negative sentiment period should turn out to be beneficial in the long run.

In conclusion:

It is most likely that the coming several weeks and months are going to be highly volatile. The VIX graph is signaling that. A long term investor should take advantage of these times to define his strategy alongside his wish list while closely monitoring the markets.

History has proven time and time again, that great opportunities come along especially during negative sentiment periods. No stock is immune from dropping in price during times of a market pullback and you should take advantage of it.

These is the time to be bold and to take actions that would be fruitful in the long run. Stay focused, think straight and pay attention for opportunities.

Happy investing.

Disclosure: I am/we are long SCHD, JNJ, T, VNQ.

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.