This week marks the biggest stock market sell-off of 2018 since February. And it's a great opportunity to discuss the art of not panicking.
As CNBC's Jim Cramer likes to say: "No one ever made a dime panicking."
If you want to invest wisely, you constantly need to be fighting off your own worst impulses [...] We're not robots, we have emotions, and those emotions can really throw you off your game."
I was not planning on writing this article today. But not long after the bell closed, something happened that compelled me to do so.
I was in a board meeting filled with very business savvy people, most of them equipped with competitive MBAs and outstanding careers in companies you are probably invested in. Someone brought up the market sell-off, and in a matter of seconds, someone else suggested it was time to move from stock to bonds because of the rise in interest rates. Two others immediately acquiesced and started to reach to their brokerage accounts. Right before my eyes, people I had always assumed would know better, started panicking.
Is it 1987 again? Is it 2008? I don't know.
But what I do know is that there have been market sell-offs almost every year since 2008. Each time, the best action has been no action at all. Heck, even if it's 2008 again, that bear market was totally erased by early 2012.
Let's review the art of not panicking.
Understanding Bull & Bear Markets
The market has historically gone up over time, with an average 10% annual return over the last 92 years for the SP&P 500 benchmark, and 74% of the years being positive.
I came across this fantastic graph from MorningStar showing bull and bear markets since the late 20’s.
- A Bull Market is measured from the lowest close reached after the market has fallen 20% or more to the next high.
- A Bear Market is defined as the index closing at least 20% down from its previous high close. Its duration is the period from the previous high to the lowest close reached after it has fallen 20% or more.
Source: MorningStar (2014).
There are two conclusions that should remain with you:
- The stock market goes up much more than it goes down (several bull markets have lasted more than ten years, at more than 17% average annualized return)
- When it goes down, it goes down fast and sharply (bear markets have lasted less than 3 years, from -22% to -83%)
Many experts argue that there was a 10-months bear market in 2015-16, depending on what index and time of the day you are tracking with the 20% threshold.
If you have run the bull market from 2009 to 2018, there has been many red days and moments of doubt, from Brexit to trade wars to general elections. Trying to time the market is a waste of time: nobody can predict it, and if you are out of the market, you are missing on the gains that the market is willing to give you over the years.
If you decide to be out of the market, you are far more likely to be wrong than right, and even more so over long periods of time.
When you invest, you are taking not only a market risk but also several specific risks.
- Market Risk: an individual stock is subject at least partially to the same volatility as the market. Think about boats moving up and down with the tide.
- Sector Risk: if the entire tech sector takes a beating, like in the early 2000’s, even solid companies like Microsoft would go down. Companies from the same sector tend to move together.
- Company Risk: the most obvious one. If a company’s business slows down or fails to deliver on expectation, or even files for bankruptcy.
By starting to invest, you have already actively made the decision to embrace market risk. The best you can do is to recognize it for what it is and let it work its magic both on the way up and on the way down.
Panic can be monitored when you take a step back from a heated situation and look at the bigger picture.
I wanted to provide readers with a look at my own portfolio draw-down. My real-money portfolio is highly volatile, mostly because it is heavy in the Technology, Communication and Discretionary sectors.
As a result, I have enjoyed a significant market beating performance, reaching 28% annual internal rate of return over the last four years. During market sell-offs, my portfolio tends to take a deeper dive, which I am perfectly fine with because volatility works both ways, and I am willing to go through the emotional roller-coaster in order to achieve an above-average performance.
This strategy is not for everyone, and it works for me only because I am very patient and invest for the next five, ten, fifteen, twenty years and beyond. I identify a market sell-off as an opportunity to buy. If that's not your natural tendency, you are probably better-off investing in index funds automatically and let someone re-balance it for you.
My real-money portfolio has taken a big hit over the last few days. Even my emerging markets positions that were already beaten down such as Alibaba (BABA) and Tencent (OTCPK:TCEHY) have particularly suffered this week.
But instead of focusing on the past week, or even the past month, I like to look at my portfolio performance over years to keep things in perspective.
As illustrated below, I might be down significantly over the last week, but it should only be observed in the grand scheme of things. My own strategy has enabled me to almost triple the S&P 500 performance. How many times has my portfolio dropped 10% in a few days, only to eventually rebound to new highs? Measuring my own performance has helped me stick to my own strategy.
So you think you understand fear and greed?
Warren Buffet wisely recommends to "Be fearful when others are greedy and greedy when others are fearful."
I was recently writing about fear and greed and how most investors have it all wrong. Even when you are buying during a market sell-off, you might be doing it wrong. Are you investing in quality companies or simply chasing bargains? Are you buying something because it is "dirt cheap" or seizing the opportunity to accumulate quality stock at a lower price following market fluctuation?
The main reason why you should be looking for quality rather that sheer value in the context of a market sell-off is that you are already benefiting from a market discount. That discount is offered usually across all types of investments, making some of the best companies more affordable.
Of course, the skeptics will say that the FAANG stocks (Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFKX) and Alphabet (GOOG)) are dramatically overvalued and should be avoided at all costs because "a market crash is coming."
Predicting an imminent crash? Isn't this the very symptom of fear?
The companies that have been particularly hurt during this recent sell-off are also some of my biggest winners, like The Trade Desk (TTD), Baozun (BZUN), Momo (MOMO), iQiyi (IQ), Square (SQ) or even Match Group (MTCH).
Adding to your winners is a powerful investment philosophy, and one that makes even more sense in the context of a market downturn. These great businesses are the very same as they were before investors started panicking, and they will still be the same after the storm passes.
The Knowable vs. The Unknowable
In a recent podcast on The Meb Faber Show, Todd Tresider explained that there are two kinds of information: the knowable, and the unknowable.
Your time and head space should be primarily focused on information and sources that are anchored in what is knowable: factual past performance, company statistics, trend analysis, business analysis, market research or best practices.
Successful investing is about risk management and business analysis – it’s not about financial forecasting.”
Because of the recent downturn, you will see many articles popping up on Seeking Alpha and around the web trying to tell you that bonds will over perform stocks this coming year, or that the FAANG stocks are about to crash, or anything in between. The reality is that you are much better off ignoring these kinds of forecasts or predictions. Half of them will be right and the other half will be wrong.
We all want to get our accounts to new all-time highs.
We do it by saving and investing.
It is a given that there are setbacks to the markets on the way to new highs. Whenever a new sell-off occurs, we are all back in the grind trying to get our account back to all-time highs.
The truth is that everybody has to go through the grind. You should not rely on an overnight success, because there is no such thing. Even Warren Buffet's portfolio is down this week. Think about it.
A sell-off is naturally shaking out the weak hands and the most emotional investors among us. Make no mistake: the grind and your capacity to go through it all is part of what makes you a great investor.
The Art of Not Panicking is not so complicated:
- Understand what bull and bear markets really are
- Evaluate the risks you are taking and why you are taking them
- Identify and recognize your emotions and keep them in check
- If you want to sell: ask yourself if your investment thesis has really changed, or whether you're simply reacting to the news cycle
- If you want to buy: ask yourself if you are merely chasing a bargain, or if you truly want to invest in this company for the long run
- Don't waste time trying to know the unknowable
- Look at the big picture: sell-offs are part of the grind, and we'll all come out stronger on the other side
My vision is mainly focused on the inexorable rise of the App Economy, the range of economic activity surrounding mobile applications. I make high-conviction bets in individual companies with a decade-long time horizon.
If you are a like-minded investor eager to find a community to share and discuss ideas with, please consider joining the App Economy Portfolio.
The service unlocks access to my real-money portfolio tracker, live alerts on trades, monthly high-conviction, and timely investment ideas.
Disclosure: I am/we are long MTCH, MOMO, SQ, TTD, BZUN, IQ, AMZN, FB, AAPL, GOOG, BABA, TCEHY. 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.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.