Originally appeared in the July, 2012 edition of the newsletter.
The current state of the market should influence your investment stance. Since 2000 we’ve been living in the midst of a bear market. The hope of a reversal of this bearish trend that seemed possible in the latter part of 2007 completely fell apart in 2008. What can we as investors learn from this period in history to better prepare ourselves for the short-term and long-term?
A theme seen throughout the market since the downturn is a greater desire for stocks that exude an aurora of safety and stability. What companies are providing products and services that will be demanded even in bad economic times? Food, drug, energy and discount retail companies have been a place many investors run when the markets become choppy.
A perfect example of a ‘safe’ stock is Altria (MO), which is the U.S. company for Phillip Morris cigarettes and other tobacco related products. MO and other similar companies have done quite well in the midst of market fluctuations. The reason for this is twofold. First, the business model is very solid. Demand does not fluctuate by much in either good or bad times. Second, the dividend payout is large, consistent and grows from time to time. In a market where volatility sometimes seems like the norm, being assured a dividend yield is very comforting for investors.
For companies such as MO that offer rock solid business models and dividends, the idea of buy and hold can be a viable alternative in a bear market. The investment is working for you through dividend distributions and the business model ensures that market dips will only temporarily hold the price down.
Buy and hold though for over 20 years now has been seen to be the rational model for the common investor. Since the early 80’s until ’00, buy and hold worked pretty darn well. Unless the company was a disaster, it likely appreciated because the direction of the market when rising (or falling) is a very powerful force in lifting stock prices up or down.
This all changed in ’00, but we could not fully understand the implications of this shift until after the market collapsed in late 2008. While markets corrected significantly in ’00, the setback was not seen as the start of a long-term bear market. The correction was perceived as being more industry specific, since the brunt of the blow was felt throughout technology companies.
Given our current historical perspective, investors should realize that investing in growth stocks is not a bad thing, even though many investors may shun the thought given current market conditions. For those that do venture into stocks that depend on significant company growth to become successful, buy and hold cannot be currently looked at as a viable strategy. Until we break into a new long-term bull market, the risk associated with the buy and hold strategy for this investment class outweighs the possible returns.
A volatile and weak economy plays havoc with most growth stocks. It’s more difficult to grow in a time of economic contraction or weak economic growth and a greater share of investors see such companies as not being worth the implied risk. Therefore, growth investors must understand the need to place clear exit points for their growth positions. It is equally important to set rules for exiting a position that has realized a profit.
A few easy and popular rules traders use when entering into positions are as follows:
- Cut your losses if a stock falls between 7%-8% below your purchase price after your initial purchase. Maintaining capital is important and hoping that losers turnaround is not a good strategy.
- Make sure the market is in an uptrend when buying. When the market is weak, even good companies will be pulled down.
- Establish an exit point or points for selling.
- Monitor noticeable changes in the stock’s volume. Depending on whether the stock appreciated or depreciated on high volume, it is a cue to investors whether institutions are buying or selling. Both are clear bullish/bearish indicators.
No matter where you stand as an investor, it is important to understand how your investing strategy fits (or doesn’t fit) in with the market environment. Make sure to not lose focus of the micro and macro picture.