Dealing With Stock Market
Corrections: Ten Do's and Don'ts
A correction is a
beautiful thing, simply the flip side of a rally, big or small. Theoretically,
even technically I'm told, corrections adjust equity prices to their actual
value or "support levels". In reality, it's much easier than that. Prices go
down because of speculator reactions to expectations of news, speculator
reactions to actual news, and investor profit taking. The two former "becauses"
are more potent than ever before because there is more self-directed money out
there than ever. And therein lies the core of correctional beauty!
Mutual Fund unit holders rarely take profits but often take losses.
Additionally, the new breed of Index Fund Speculators is ready for a reality
smack up alongside the head. Thus, if this brief little hiccup becomes
considerably more serious, new investment opportunities will be
abundant!
Here's a list
of ten things to think about doing, or to avoid doing, during corrections of any
magnitude:
1. Your present Asset
Allocation should be tuned in to your long-term goals and objectives. Resist
the urge to decrease your Equity allocation because you expect a further
fall in stock prices. That would be an attempt to time the market, which is
(rather obviously) impossible. Asset Allocation decisions should have nothing to
do with stock market expectations.
2. Take a look at the
past. There has never been a correction that has not proven to be a buying
opportunity, so start collecting a diverse group of high quality, dividend
paying, NYSE companies as they move lower in price. I start shopping at 20%
below the 52-week high water mark... the shelves are beginning to become
full.
3. Don't hoard that
"smart cash" you accumulated during the last rally, and don't look back and
get yourself agitated because you might buy some issues too soon. There are no
crystal balls, and no place for hindsight in an investment strategy. Buying too
soon, in the right portfolio percentage, is nearly as important to long-term
investment success as selling too soon is during
rallies.
4. Take a look at the
future. Nope, you can't tell when the rally will come or how long it will
last. If you are buying quality equities now (as you certainly could be) you
will be able to love the rally even more than you did the last time... as you
take yet another round of profits. Smiles broaden with each new realized gain,
especially when most Wall Streeters are still just scratchin' their
heads.
5. As (or if) the
correction continues, buy more slowly as opposed to more quickly, and establish
new positions incompletely. Hope for a short and steep decline, but prepare for
a long one. There's more to Shop at The Gap than meets the eye, and you
want to run out of cash well before the new rally
begins.
6. Your understanding and
use of the Smart Cash concept has proven the wisdom of The Investor's Creed
(look it up). You should be out of cash while the market is still
correcting... it gets less scary each time. As long your cash flow continues
unabated, the change in market value is merely a perceptual
issue.
7. Note that your Working
Capital is still growing, in spite of falling prices, and examine your holdings
for opportunities to average down on cost per share or to increase yield (on
fixed income securities). Examine both fundamentals and price, lean hard
on your experience, and don't force the issue.
8. Identify new buying
opportunities using a consistent set of rules, rally or correction. That way you
will always know which of the two you are dealing with in spite of what the Wall
Street propaganda mill spits out. Focus on value stocks; it's just
easier, as well as being less risky, and better for your peace of mind. Just
think where you would be today had you heeded this advice years
ago...
9. Examine your portfolio's
performance: with your asset allocation and investment objectives clearly in
focus; in terms of market and interest rate cycles as opposed to calendar
Quarters (never do that) and Years; and only with the use of the Working Capital
Model (look this up also), because it allows for your personal asset allocation.
Remember, there is really no single index number
to use for comparison purposes with a properly designed value
portfolio.
10. So long as
everything is down, there is nothing to worry about. Downgraded (or simply
lazy) portfolio holdings should not be discarded during general or group
specific weakness. Unless of course, you don't have the courage to get rid of
them during rallies... also general or sector specifical (sic).
Corrections (of
all types) will vary in depth and duration, and both characteristics are clearly
visible only in institutional grade rear view mirrors. The short and deep ones
are most lovable (kind of like men, I'm told); the long and slow ones are more
difficult to deal with. Most recent corrections have been short (August and
September, '05; April though June, '06) and difficult to take advantage of with
Mutual Funds. So if you over-think the environment or over-cook the research,
you'll miss the party. Unlike many things in life, Stock Market realities
need to be dealt with quickly, decisively, and with zero hindsight. Because amid
all of the uncertainty, there is one indisputable fact that reads equally well
in either market direction: there has never been a correction/rally that has not
succumbed to the next rally/correction...
Steve
Selengut
http://www.sancoservices.com
http://www.valuestockbuylistprogram.com
Professional Portfolio
Management since 1979
Author of: "The
Brainwashing of the American Investor: The Book that Wall Street Does Not Want
YOU to Read", and "A Millionaire's Secret Investment
Strategy"