Wednesday, August 23, 2017

A Lesson From History: Market Does Not Go Down In A Straight Line

During the 2009 market crash, we had three chances to get out before the market took a nose dive. Once you miss these chances, you better hold-on tight and make sure you don't own any low quality stocks.

2009 Market Crash


And below is how the market looks in 2017. There have been at least a few times when the S&P 500 has gone below its 50 day moving average (the yellow line).

However, the long-term trend, the green line is still trending upwards which indicates that bull market is in fact still intact.

2017 Market Snapshot
The recent market pull-back of 1-2% may be nothing or it could just be the very first sign of weakness. It could also be a warning of an impending market crash.

It only takes a small catalyst to bring down a weak market. The catalyst can be anything from a political uncertainty to a broader geopolitical event.

It Will Be All Okay In The Long-Term, 
But Only If You Buy High Quality Investments

I often hear from investors to not worry about the buying price of a stock or an impending market crash as in the long run it will all even out and prices will recover and even grow another 10%-20%.

The problem I see with the above thinking is that it is mainly true if you own high quality stocks. When market is at all time high, people have tendency to become more complacent and buy low quality investments such as high dividend stocks or high yielding junk bonds.

If you get caught holding such low quality stocks during an economic downturn or a recession, there is a high probability that those stocks may never recover from the downturn and end up going to zero (bankruptcy) either during or soon after the start of a recession.

But What About Bitcoins?

There is currently a herd mentality that has taken over the bitcoin and cryptocurrency markets. It has resulted in sky rocketing of these currencies' prices and a bubble has formed.

There are currently over 1000 cryptocurrencies out there and more on the way.

Essentially, anyone can create their own version of a cryptocurrency by signing-up with one of the services that give you everything you need to start your own currency.

How do you know which one to buy? You can go with the popular ones. But popularity can change pretty quickly.

The entire cryptocurrency scene reminds me of the dot.com bubble where .com companies were springing up left and right and people were buying stock in those companies hand over fist in hopes for making big.

Investing in cryptocurrencies is not investing. It is gambling folks! And, we all know how it all ended in 2000.

To be clear, I'm not saying all cryptocurrencies will die or are a fad, what I am saying is that the current expansion in cryptocurrencies is unsustainable and mainly driven by a herd mentality without a stable intrinsic value. This is also why these currencies are so volatile.

There is no central regulation of these currencies which makes them unstable and susceptible to fraud and unsuitable as a legal tender.

I believe it is more prudent to invest in the technology behind cryptocurrency rather than the currency itself. The technology behind cryptocurrencies is Blockchain. There are several well known companies that are providing hardware and software to enable and improve blockchain technology.

Blockchain has application well beyond cryptocurrencies and if I were to invest, it would be in companies that enable blockchain and not the currency itself.

Before investing in the current market, one should ask themselves the following questions:

1. How do I feel about overall economy? (Feel Good = Yes, otherwise= No)
2. Do I feel my job is safe, even if we hit a recession?
3. Can I hold-on to my investments even if they remain underwater for 5 to 6 years?
4. During a downturn, would I be able to keep my investments intact, even if I lose my job?
5. Do I have enough cash to buy investments during a downturn or a crash?

If the answer to any of the above questions is 'No', then one should not be investing in the current market outside of their retirement accounts.

What history tells us is that market does not go down in one swift move. Market will give us ample warnings in the form of dips and quick but incrementally weaker recoveries before taking a final plunge.

Nobody knows how many of these warnings we will get before the final plunge, but one thing for sure, in the short-term (six to eight months) there is a greater downward risk than upward opportunity.

It is difficult to time or predict when market will go down, all we can do is carefully watch market fundamentals and prepare our portfolio to manage the risk by only buying high quality investments at fair or below fair value and by keeping ample cash on the sidelines to benefit from any impending market plunge.

Disclaimer: Author of this article is not a licensed/registered financial or investment adviser and does not provide investment advice. Any mention of stock names/tickers in this article or website is not a recommendation to buy or sell. This article is for informational and entertainment purposes only. Full disclaimer can be read here: Full Disclaimer

12 comments:

  1. Excellent advice, Mr. ATM!
    I especially like that you pointed out the gambling/herd mentality surrounding bitcoin. I'm not an investor in bitcoin, but I do agree with you that the technology behind it is what is worth investing in. I also enjoyed your check list. You gotta have a 5 year time frame minimum to be investing in stocks. If I massive market correction did occur, I am pretty certain my job would remain in tact. It would perhaps be even more in demand. Also, high quality stocks is so important! You have to be confident in the companies you hold. Thanks for sharing!

    ReplyDelete
  2. Question number 1 isn't really a yes/ no answer. But very valid points and good analysis. Many "experts" are predicting a crash in the near future. But as long as your job is safe and you have enough to survive on during the downturn, that is when the most money is able to be made from the market in the long run once it rebounds. Would be interesting to see it happen again. Was not in the position or stage in life to invest during the last crash. I think since then, a lot of people have tried to prepare themselves just in case. Thanks for sharing.

    ReplyDelete
    Replies
    1. Thanks DD, I added Yes/No definition to question #1. Thanks for pointing out.

      I was in the early stages of my career in 2000 and even had some money in the stock market at the time, but I was mostly invested in blue chip stocks like INTC. I was fortunate that I also worked for Intel at the time and not some unproven .com company that laid-off ton of people during that time. It was quite bad and I still have clear memories of that time and that serves me a good lesson.

      Delete
  3. With the stock market is breaking the records every couple of months, A correction or a crash is imminent. But I'm still buying with my retirement account. That's property about $2K/mo. With my taxable account, I'm buying company that already crashed or crashing hard - down 30-70%, but I know they are not going away, and hoard the rest of the cash to put in "emergency savings". LOL :)

    I guess I'm stuck in the 2 more years mindset. I'm making more than enough between my taxable account and my rentals. But Just in case there is a downturn, I'd like to work during that time to maximize my future income. As I do have this fear that we don't have stable sustainable health insurance with Obamacare is under threat, and should something happen, it would eat right through my savings.

    ReplyDelete
    Replies
    1. You are doing the prudent thing with regards to "emergency savings" given the state of healthcare expenses.

      Also one should not stop investing in retirement accounts as those accounts are for the very long-term investment horizon and can weather market ups/downs much better.

      Good luck with your investments

      Delete
  4. Interesting perspective Mr. ATM and thanks for sharing it. I really like your analysis of the crypto-development. Although I believe that a few of the coins will survive as payment it is important to note that the technology behind the coins has the potential to replace existing tech.

    ReplyDelete
    Replies
    1. Good point regarding replacement of existing tech and thanks for sharing Mr. Robot.

      Delete
  5. I think you want the answer to question #4 be no, and not actually yes. So, if I'm not forced to sell my stocks if I lose my job, then that's a good thing because I'm in a strong financial position.

    In any case, I agree with the overall points of the post, which is why I'm invested for the super long term, long enough to withstand a market correction. I do admit that I am one of those folks interested in bitcoins, but if and when I do, I would fully understand the risks of the investment - even if it's more like gambling, which I also love to do.

    Great post Mr. ATM.

    ReplyDelete
    Replies
    1. Hi DP, yes you are right, I corrected the wording on question #4. Thanks for pointing out.

      I think you have the right mindset towards investing in bitcoin or any investment for that matter. One should always understand all the risks involved before investing.

      Delete
  6. Crypto currencies don't interest me at the moment, far too volatile for my tastes. I'm still mid 30's and in the accumulation stage so I just keep putting money in. I would like a market pullback selfishly but not a crash by any means. I don't wish other people to suffer for my gains. But a period of lower priced stocks while I'm accumulating would be nice! Thanks for the info!

    ReplyDelete
    Replies
    1. Hi DS,

      I feel the same way, crypto-currencies are way too volatile for my taste. A pullback or even a 10-20% correction would be nice. I don't want recession either; however given the historic expansion in stock market valuations, weak economic growth, and all time high complacency among investors, a major downturn or an outright recession is not out of question.

      Thanks for commenting and sharing your thoughts.

      All the best.

      Delete