Crazy Markets, Smart Plan
Last week I wrote about the difference in how institutional money and the average investor thinks about investing (Retail Investors vs Institutional Money). The main differences being that Retail investors are focused on performance/yield and with Institutional investors, their primary focus is risk management. Additionally, institutional investors have a much longer time horizon on their investments. It is during periods like this when the markets are crazy that these measures really prove beneficial.
These measures are an important component that all individuals should be mindful of. They should be a part of all financial independence plan.
The Arrest Of Huawei CFO
Meng Wanzhou, the CFO and daughter of the Huawei founder Ren Zhengfei was arrested in Vancouver Canada and may be extradited to the United States. Huawei is accused of continuing to ship products to Iran despite U.S. sanctions.
They the world’s second-largest seller of phones behind Samsung and is a well-known brand in China for consumer electronics (TVs, laptops and tablets). Huawei also manufactures telecommunication equipment which is sold around the world.
US lawmakers have prevented American companies from buying equipment from Huawei in fear of spying concerns. The US government has also encouraged its allies to stop purchasing Huawei equipment.
China and the US have agreed to put their trade war on hold. Trump has agreed to leave tariffs on $200 billion worth of products at 10 percent and not raise it to 25 percent. China has agreed to purchase a substantial amount of agriculture, energy, industrial and other products to reduce the trade imbalance. Both parties aim to have an agreement in place in the next 90 days.
However, this agreement was made one day before Meng’s arrest. The arrest has increased concerns of escalating tension with China and the US. China is demanding the release of Meng immediately and has threatened repercussion.
The continuing turmoil of Brexit (Britain leaving the European Union) is creating uncertainty for many European and US multinational companies. Theresa May, the Prime Minister of Britain is facing major hurdles as she works on a deal. In the past 12 months, May has lost one foreign secretary, two Brexit secretaries and six other ministers over Brexit. There are less than 100 days to go before the UK is to leave the EU (March 29, 2019).
In December there was an inversion of the 3-year and 5-year interest rate. This occurs when the 3-year rate is higher than the 5-year rate. Under normal circumstances, longer-term rates are higher than the short term.
An inversion of the yield curve, in most cases, have historically preceded a recession by about 1 to 3 years. Although the 3-year and 5-year interest rate inverted the 2-year and 10-year have not. The 2-year and 10-year interest rates are the actual indicators used as the barometer. Unfortunately, the media headlines only highlight a yield curve inversion (3-5) and warn of a potential recession, this creates fear in the general public.
Oil prices continued its slide to around $45 per barrel down 24% this year and reaching 17-month lows. Although low oil prices are good for the average consumer at the pumps, low oil prices are an indication of a slowing global economy. Lower demands globally and increased shale production from the US have resulted in excess inventory. OPEC and Russia have agreed to reduced production but there are concerns that it may not be enough to significantly impact the price. Additional cuts may be required.
Prior to the interest rate decision by the FEDs, Donald Trump sent out a series of tweets directed at Jerome Powell the Federal Reserve chairman. Trump called out to JP to leave rates as they were. The Feds use interest rates as a tool to manage the money supply and promote financial stability (inflation & employment level). Increasing interest rates help reduce inflation (target ~2% annually) but also slows down the economy.
JP did not heed Trump’s tweets and raised the benchmark rate a fourth time in 2018 to a range of 2.25 to 2.5 percent. The markets were expecting this rate increase but hoped for an indication of a measured wait and see approach to future rate decisions. However, JP included language indicating additional rate hikes in 2019 is appropriate. This decision resulted in a 700 point movement in the Dow which started 300 points up prior to the rate announcement. The Dow closed down 414.23 points at 22,445.37.
- The Dow lost 6.8 percent and 1,655 points on the week. It was its worst percentage drop since October 2008.
- The Nasdaq lost 8.3 percent on the week and is now 22 percent below its record reached in August, a bear market.
- The S&P 500 lost 7 percent for the week and is now down 17.8 percent from its record.
- The Dow and S&P 500, which are both in corrections, are on track for their worst December performance since the Great Depression in 1931, down more than 12 percent each this month.
- Both the Dow and the S&P 500 are now in the red for 2018 by at least 9 percent.
How This Relates
In last week’s post, I provided some examples of how Institutional money manage risk (Retail Investors vs Institutional Money). Some of the measures like purchasing puts will protect against downward movement albeit at a cost. In times like this the costs seem well worth it but during long upward trends these costs add up.
Other measures like asset allocation or Low Volatility (LV) investing reduces but doesn’t eliminate the swings in your portfolio. Increasing the fixed income component of your portfolio will reduce volatility but could also reduce long-term gains. LV investing does have its advantages but do you have the knowledge to select LV securities or are you willing to pay the management fee for a LV mutual fund.
Do volatile markets keep you up at night and are you willing to accept slightly less than market returns? You need to decide if these costs are worth it.
The other component that’s important to investment success is having a long-term investment horizon and sticking with your financial independence plan. At times like this, you must remind yourself that the stock market moves in cycles and we’ve been in the longest bull market since WWII. Eventually, there will be a bear market but if you have a long-term time horizon and are able to take advantage of dollar cost averaging these pull-backs are a godsend, especially if you’re a dividend investor.
As a dividend investor, you can take advantage of these pull-backs to purchase more shares at a discount. You also get the advantage of your DRIPs acquiring more shares. It is tough watching a stock you just purchased drop 10 to 15 percent but you have to remind yourself that you’re in this for the long haul. Eventually, these stocks will rebound and you get paid to wait.
As an individual investor, these past few weeks tests the resolve of your investment philosophy. It’s easy to stick to your plan when the market is trending up, everyone looks like they know what they are doing. Its when the markets pull back that really demonstrates the strength of your investment plan. It also tests your ability to ignore your impulse to sell stocks for fear of more pain. In truth, bear markets are a great opportunity to buy more quality dividend stocks at a great price. It’s like what Warren Buffet says “Be fearful when others are greedy, and be greedy when others are fearful”. We are getting to the point where there is a lot of fear in the markets. Is this the bottom? I don’t know, nobody really does but if you stick to your long-term financial independence plan it won’t matter.