How bad? Well… on Friday, February 2 the S&P 500 closed at 2,762 points and on Friday, February 9 it ended up at 2,620, representing a drop of 5.1%. All of this accompanied with wild swings in between. In Hong Kong, same story but worse. The Hang Seng Index went from 32,602 on February 2 to 29,507 on February 9, indicating a drop of 9.5%(!)
As you might have noticed, I rarely write about recent market conditions as I normally don’t have anything relevant to say about it. However, after last week’s damage, I got a few questions and thought it would be interesting to revisit a few concepts and provide you with some feedback.
The first question is why did this happen? As for many systems in existence, it was due to a combination of factors rather than one specific reason. Some of the factors you want to consider are 1) the length of the latest bull cycle making a lot of investors/traders nervous, linked to 2) where we are in the economic cycle, and 3) pure panic. I never listen to what economists have to say, but when I do listen to someone talk about more macro type of factors, that person often is Ray Dalio. In this instance, once again he provided the best (and shortest) explanation I have found.
“Over the past week or so, we had reports of strong growth and rising wages (good things!), which sent bonds and stocks down (bad for most investors) due to justifiable fears that the Fed will tighten faster than is priced in the credit markets. The surge in growth and wages came because of both the fiscal stimulation and the rekindling of animal spirits, thrusting the economy into late-cycle capacity constraints, which is leading to the expectations of faster Fed tightening.”
Top value fund managers are ready for the small cap bear market to be done
During the bull market, small caps haven't been performing well, but some believe that could be about to change. Breach Inlet Founder and Portfolio Manager Chris Colvin and Gradient Investments President Michael Binger both expect small caps to take off. Q1 2020 hedge fund letters, conferences and more However, not everyone is convinced. BTIG strategist Read More
– Ray Dalio – February 5, 2018
You can find the full article here.
The next question is, why last week and why that severe (or why not even worse)? To this question, I have no answer and I haven’t spent one minute trying to forecast the market. In the short term, markets are irrational and so, personally, I find it quite difficult to have a rational opinion about an irrational concept.
A more interesting question is what did I do and how did I react? The following quote has been on my computer’s wallpaper for several months now and I find it quite relevant today.
“But I try not to think with my gut. If I’m serious about understanding the world, thinking with anything besides my brain, as tempting as that might be, is likely to get me into trouble.”
– Carl Sagan
Carl Sagan was an American scientist (astronomer, cosmologist, astrophysicist, etc.) and wrote hundreds of scientific papers and articles, in addition to books and television series. Although he wasn’t an investor, he knew that reacting to his instinct could lead him to taking very bad decisions. By being aware of this, although it can be nerve racking to see recently added positions decline in value, I took a step back and didn’t move. In a sense, I found myself quite “lucky” last week as an important part of my portfolio is currently in cash. But is it really “luck”? Although I look at several potential targets, I haven’t bought a lot recently mainly due to increasingly high valuations. In addition, I sold a large position about 2-3 weeks ago which I had held for a relatively long period of time and which its valuation went through the roof since my purchase. So, by looking at my recent activities (or inactivity), even if it might seem like I was “lucky”, I was simply following my investment philosophy – which I explained at length in previous posts.
One thing that I realized last week though, is how busy I might be in the next few months if the market keeps going down – which is quite stimulating! I’ll probably have to review a lot of the targets I’m following and slowly start buying. We might have a bargain season just around the corner!
Crash or not, at the end of the day, as an investor what you want is to be as consistent as possible in your approach. In the long term, you should be immensely rewarded!
Next post, next week!
Keep growing your snowball!