Your Investments: Sharp market sell-off: What now?

As we have seen so many times in the past, once the market bottoms out, it tends to roar back very strongly, and if you miss that big jump, it will take you a long time to recover from the damage.

By AARON KATSMAN
October 6, 2011 22:59
4 minute read.
Tokyo Stock Exchange employee reacts to fall

Tokyo Stock Exchange employee reacts to fall 311 (R). (photo credit: REUTERS/Kim Kyung-Hoon)

 
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Earlier this week the S&P 500 index dropped into bear-market territory, defined as a fall of 20 percent. Year-to-date emerging- market indices are off more than 30%, the Israeli stock market is down 25%, and investors are running scared as the prospect of another market crash haunts them.

One of the most common questions that I receive goes something like this: “Why should I be investing in the stock market while the global economy is headed toward a double-dip recession?” This is certainly a reasonable question. After all, US unemployment remains very high, countries in Europe are on the verge of bankruptcy, questions remain as to the solvency of banks, and I could go on and on.

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With all this turmoil, the question is what should investors do with their portfolios?

DISCONNECT

While many investors believe that stocks prices act in unison with economic performance, the fact is that in many instances, there is little relation between the two.

According to financial planner Matt Montgomery: “There has always been an interesting disconnect between the economy and the stock market. Many investors believe the economy and the stock market walk in lockstep. If the economic news is good, they assume the stock market will go up. If the economic news is bad, they assume the stock market should decline.

Unfortunately, it just isn’t that simple.

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If it were, investing would be easy. But history shows the economy and the stock market have a very uneven and bumpy relationship.”

The recent global recession, while painful for the average Joe, was a wake-up call for corporations worldwide. In order to stay afloat, many companies resorted to cutting costs and trimming unnecessary organizational fat. Anticipating a prolonged business slowdown, they were faced with the option of either massively lowering costs – which entailed huge layoffs – and trying to weather the storm, or continue to be bloated and face massive losses and eventual bankruptcy.

For the last 12 months or so many corporations have been reporting record profits. Even as the general economy stinks, these companies continues to print money and to quote the 1980s one-hit wonder band Timbuk 3: “The future’s so bright, I gotta wear shades.”

If corporations continue to be optimistic about their businesses, why is the market in “crash” mode? Well the cloud of a Greek default is certainly still driving the markets. Each day that we get a whiff of positive news the stock markets jumps ahead, only to fall back even more upon bad news.

That being said, stock prices are cheap. Now, I am not saying that they can’t be a heck of a lot cheaper in another month, it’s just that when you have great companies, executing their business plans to perfection, pay 3%-5% dividends and have dropped by 20%, it may be a good time to start buying them.

I am not blind to the fact that you need a strong stomach to start taking positions in a market like we have. And for investors that like the bargains out there but are fearful of further drops, the solution may be to “leg in” to the market.

This means that you don’t take all of your money and go out and buy stocks; rather, you take a quarter or a third now and buy, and then in a month from now you reevaluate, and depending on market circumstances, you put in another quarter or third and so on. This “legging in” approach allows you to gain some market exposure, in a measured fashion.

ALREADY IN

This “leg in” approach may sound good to new investors or those sitting with large amounts of cash. But what should investors who are fully invested do? That depends on your situation.

If you are a retiree and you can’t afford to lose money, then you probably shouldn’t have had so much exposure to the market to begin with, and even now you should get your portfolio more conservative. If you are younger and have more time, it may pay to hold on and stay the course.

As we have seen so many times in the past, once the market bottoms out, it tends to roar back very strongly, and if you miss that big jump, it will take you a long time to recover from the damage.

Speak to your financial professional to see if you should have more exposure to the stock market and how that fits in with your overall financial plan.

aaron@lighthousecapital.co.il

Aaron Katsman is a licensed financial adviser in Israel and the United States who helps people with US investment accounts.

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