What a wild ride! The stock market never ceases to amaze during times of mass panic and fear. With the S&P 500 now down roughly 20% from the peak that was made not even 3 weeks ago, we have witnessed this new age of volatility. The speed and magnitude of this correction has taken a lot of investors by surprise, and therefore have trapped a massive amount of money above the $2950 level on the S&P.
During difficult times like these, it’s extremely easy to fall prey to your emotional fear of loss, and part of reason is due to the constant bombardment from every single area of news/social media. When stock markets crash, you start seeing more and more doomsday talk from people who normally has no interest in the markets. Now I don’t follow all of Buffet’s theories on investing, but his famous quote that refers to sentiment was spot on, “Be fearful when others are greedy, and be greedy when others are fearful.” It is never comfortable to invest in a market crash, but it has always been the most logical thing to do. So let’s get into the technicals and see how we should invest given the news from today.
Sentiment has finally turned negative, good sign for bulls!
If you have read some of my previous posts, you’ll have seen me use the AAII Bull/Bear Sentiment Survey as a primary leading indicator of where the stock market will go. This indicator works from a contrarian point of view, so it means you should be bullish if the indicator is flashing bearish, and vice versa. The reason this type of sentiment indicator works is because the stock market operates in waves of optimism and pessimism, which creates the choppy patterns that you see in the market. When the AAII Bull/Bear spread is greater than 20%, that means there’s 20% more people that have a bullish outlook than a bearish one, therefore the market should have already priced the positive fundamentals into stock prices. If everyone is expecting positive things to happen, then the logical thing to expect is that a negative surprise will shock the market.
The current situation is the opposite of the scenario described above, we currently have 20% more bearish outlooks than bullish, and that gives me comfort to start slowly adding back my equity weighting in my portfolio. With that said, please remember that we’re only using this indicator to tilt the probability of success in our favor, it does not tell you where the exact bottom will be nor how long it’ll take to get there. However, having a sentiment of less than -20% is telling me that I’m buying into fear, which is always a good thing.
We know that it’s a good time to start slowly adding stocks, but how much should you add at a time and how long should you take to get to the maximum target weight?
Slow and steady wins the race!
If you read my last post, you’ll know that I talked about the average duration of market corrections during recessions and non-recessions. Market crashes that did not result in a recession lasted on average 13 weeks, and crashes that was accompanied by a major economic recession lasted anywhere from 72 weeks to 132 weeks. The average decline of the S&P during those recessions were around 50% from the all-time-high. Just to give you some perspective, we were down 27% at one point during the week.
If you’re wondering why not just wait until it drops further towards the 50% mark, surely this looks like a recession is coming? If you truly believe that this virus will cause a major economic recession with people defaulting on their debt, losing their jobs permanently, and generally going bankrupt, then yes you should wait further until that happens. But for the rest of us, I am comfortable operating under the paradigm that it is almost impossible to know for certain whether a recession is coming or if it’s already happening. Given the magnitude of the recent drawdown, the risk vs reward of slowly putting your cash to work is starting to look very enticing to me. Especially when you know that there is extreme fear in the markets and others are panic selling at the first chance they get.
My base-case scenario (an educated guess) is that this will not cause a sustained recession, please scroll to the bottom of this post for my reasoning.
The strategy that I recommend is to stagger your stock purchases, essentially making use of the average down technique (learn more on my tips and tricks page). For example, I sold my equity position before this Coronavirus crash by 50%, so my portfolio became 50% equity, 30% Long-term treasuries, and 20% cash. With my target of 100% equity weight in mind, I bought 5% into Microsoft shares on Thursday (Mar. 12) during the 9% drop in the S&P and will continue to add 5% each time throughout the next 9-10 weeks, during large selloff days.
I want to emphasize that I am not saying this is the bottom and that we won’t go lower. In fact, I am almost certain that the selling will resume because we’re only at week #4 out of the average 13 weeks in a correction (without recession). Instead, I am simply betting on the odds that this could potentially be the low. If I am wrong, I am more than happy to continue deploying the other 45% (selling treasuries as we drop further) of my portfolio into stocks at a lower level.
In summary, I recommend that you start slowly staggering in your stock purchases for the upcoming weeks during market selloffs. But whatever you do, do not fall prey to Fear-Of-Missing-Out (FOMO). There will be short-term market rallies where the market may jump 10+% and it feels like you’re going to miss the train back up, but these rallies tend to be weak and it gets sold into quickly by the people that haven’t had a chance to sell yet. You should be looking to buy during days where the market is down due to further negative news headlines.
If you want to see exactly when I buy my stocks and what stocks I’m buying, please head over to “My Portfolio” page and create a free account on TipRanks to see my transactions. I am not sponsored by them in any way, it’s just an easy method to publicly show my holdings.
Recession Probability Update
Remember the monetary and fiscal stimulus I talked about in my previous post? Well we saw that exact response from the Federal Reserve (Fed) and Government this week.
In terms of Monetary stimulus, the Fed came out this week with a historic sum of liquidity provisions, in the form of a $1.5 Trillion dollar injection into the money markets and short-term treasuries. This injection will allow money markets to maintain stability, which is crucial because the short-term treasury market is the most active and liquid market in the world, and many users rely on it to properly execute their investment strategies. Alongside the trillion-dollar injection, the Fed has also authorized the purchase of bonds across all maturities for its $60 billion dollar reserve-management purchase plan. Additionally, the street is expecting the Fed to lower interest rates by another 50 bps during their next meeting this upcoming week.
On the Fiscal policy front, the Trump administration announced this week that they’re working on a tax cut policy which could potentially cut income taxes to 0% for 2020, unlocking around $1 trillion dollars for consumers to spend if they choose to. It has also been rumored that multiple debt relief packages are in the works and could potentially include temporary debt repayment suspensions, much like how Italy suspended mortgage payments.
Like I said last week, these increasingly stimulatory policies coming from both monetary and fiscal sources will have a positive impact over the longer term. However, in the very near term, we must face the reality where countries and businesses are completely shutting down. With consumers rushing to stockpile essential supplies and bunkering down, the extra cash from tax cuts will not be deployed back into the economy. Until we have the virus situation under control, a significant portion of consumer consumption will be limited, simply because there’s just nowhere to spend your money. In summary, while the government’s policies will not be particularly effective in the short term, the longer-term benefit will start to show after this virus craze is over. The most important thing to remember is to not be consumed by the doomsday talk. Even if this leads to a recession, there hasn’t been a recession in history where we’ve never climbed out. Focus on the risk vs reward when you add to your equity weighting and find opportunities through this chaos. Get used to seeing red in your account, it’s a necessary skill to be successful in the long run. It will never be comfortable to invest in market crashes, but it has always been the most logical strategy. You want to buy low, sell high… right?