I know the posts this week weren’t the most upbeat, but hey, I’m not CNBC. My job is to be a fiduciary on behalf of my clients which means I need to be realistic. I understand that it’s more enjoyable to read about exciting, new investment opportunities so I try to limit the doom and gloom. However, the primary purpose of this blog is a means of communication with my clients to keep them informed and sometimes that means I need to talk about the unbalanced risks in the markets. I think the important thing to keep in mind though, is that risk and opportunity are opposite sides of the same coin. I get excited about big risks in the markets because they lead to big opportunities!
It’s always been a belief of mine that a falling market only hurts to those that are already fully invested. If you’re fully invested, you are unable to take advantage of the opportunities created during times of chaos and panic. It’s a key investment principle I follow to always have some sort of reserve on hand so we’re able to step in when others are being forced out. Markets are rarely trading at fair value. They tend to cycle back and forth between periods of overvaluation and undervaluation. The short periods when volatility spikes and assets are put on sale (undervalued) are the absolute best times to make new investments – the key word being investments.
There’s a big difference between trading and investing. When investing, you invest in businesses, not stocks. The stock is simply the mechanism which represents the ownership of the business. In trading, you buy something “because it’s going up.” Most people want the stock market “to go up.” This is a trading mentality and it’s the enemy of sound investing. It also helps explain why so many people “buy high” and “sell low.” They chase things that are “going up” and panic and bail on things that are “going down.” When in reality, a falling stock represents a better deal when making an investment so long as the underlying business isn’t falling apart. The shares still represent ownership of the same underlying company. The only difference is the price you pay, and when it comes to investing, the price you pay determines your future return. Said another way, if you buy an overvalued, expensive security (buying “high”), it’s more than likely going to lead to poor investment returns (possibly negative) over the long haul. If you buy an undervalued security, it’s probably going to lead to strong future returns.
When working with my clients, we always start with their financial plan and then tailor their portfolio to match that plan (theirs goals, spending, etc.). This means we’re running projections out 30+ years while making assumptions about the geometric average annual rate of return that we’ll be able to earn. The issue I have with most stocks today, and certainly the broad-based US market as a whole, is that they’re trading at very expensive valuations. Mathematically speaking, it’s going to be difficult to earn the assumed rates of return built into my client’s plans at current prices (i.e. current valuations are predicting low future returns over the next decade). A company’s future profit potential is what it is – it’s just a question of what you’re willing to pay to have an ownership right (shares of stock) to those profits. When buying stocks today, you’re simply paying too much in relation to the amount of future profits. This is why I want the stock market to fall. I would like to buy ownership of all of the great companies out there at cheaper prices. It will improve the likelihood of success of a financial plan. That is, as long as you’re not already fully invested and unable to take advantage of lower prices.
Do we currently own stocks? Of course we do! We own a bunch of stocks. But I’ve handpicked the list of stocks that I feel are smart to own right now AND I’ve hedged them with options. Additionally, we have a pretty good amount of money currently in reserves (cash, bonds, etc.) just waiting for a better time to invest. That time will come; it always does. It’s my opinion that it’s worth accepting lower (but positive) returns today to wait for better long-term return opportunities.
Risk, volatility and falling markets? Bring ’em on, I’m waiting and ready. Now is the time you build your shopping list. You look into your crystal ball about how the world is changing and what long-term demographic and macro themes will be driving those changes, and then wait to buy stock on the cheap in the companies that will benefit. I always have a list of companies I’d like to buy ready. This week I just added two new companies to the list – two very exciting stories. But I’m not willing to buy them today, at current prices. The one I’d be willing to buy if it dropped about 10% and the other I’d like to see fall about 20%. I understand it can be tough to watch certain stocks rise day after day when you’d like to own them but don’t. But successful investing takes discipline and a lot of patience. Right now, it’s time to be patient and to let the risks play out so we’re ready to step in when they transform into opportunities.
Thanks for following and have a great weekend!
-Nick
Agreed