Speed Bump Ahead, Watch Your Speed
Although it’s easy to forget sometimes, a share is not a lottery ticket. It’s part ownership of a business.
The next time share prices take a tumble, don't panic — it was bound to happen sooner or later. Stock markets in 2020 took many people by surprise with a good performance (as long as your exposure was diversified with a low concentration in companies in tourism-related sectors), and so far, this strong performance has continued into 2021.
Global vaccine rollouts, better economic growth, rising consumer confidence has fuelled the feeling that we are turning the corner in the pandemic fight. Whilst enjoying the returns that the market is giving us, we must also be aware that markets will inevitably hit a speed bump somewhere down the road. This happens from time to time, and although past performance is not a reliable indicator of future results, a correction is most often nothing to be concerned about.
The best time to prepare your portfolio and your mental framework for such an event is now — when it’s clear skies and smooth sailing.
Know Your Threshold
Everyone loves making money. Sometimes we get so caught up in the race that we willingly plough our hard-earned savings into risky investments for the chance to make more, only to feel regret when things take a turn for the worse. By then, it is too late. There are far too many cautionary tales of bust rather than boom when it comes to investing. (Perils of being day traders , Man loses $50,000 in Investment Scam, 1 of more than 200 victims — The Straits Times)
Take a step back and consider how much you can lose before you actually lose sleep over it. Important life events will also determine whether you should dial back on the risky assets in your portfolio. For instance, if you are planning to stop working in three years or less, then it is prudent that your investment allocation includes a bigger chunk of high quality bonds to buffer against market volatility and losses. This will be in contrast when you have the scenario of a younger person who has just entered the workforce — being someone with a long runway, high human capital, and is able to use time to withstand market shocks allows for a higher risk profile.
If you like to DIY or want to read up more, there are numerous resources on asset allocation available for reference like this one by Vanguard. However, take note that the returns are in USD and the shorter term expected returns for bonds are likely to be lower because of where interest rates are presently.
Rebalancing
If the correction is underway and you have constructed your investment portfolio in a proper manner, then you can initiate a rebalancing — which is akin to systematic market timing. In a market sell-off, this helps you to recover losses quickly and generate a return. When markets are good, you trim the profits and simultaneously neutralise the risk in your portfolio. This is shown in the diagram below.
What Signals are the Market Showing?
While we have no way to predict when the correction will occur, there will be some indicators present in the market that can give us some clues on whether that probability is high or low.
Market Health — it is generally measured via the participation of stocks in up and down days. Larger company stocks typically have higher influence over index prices and their movements sometimes masks what is happening to the rest of the stock market. As such, we want to find out how the entire global stock market is performing both in the short term (50-day moving average) and longer term (200-day moving average). The diagram below shows that the market is currently still healthy with over 60% of stocks having positive short-term momentum and over 70% of stocks having positive long-term momentum. With such strength, any correction that is ahead of us will not be excessively large in magnitude, and will be relatively shorter-lived.
Market Momentum — Nobel laureate Eugene Fama’s research together with Kenneth French showed that momentum was an “anomaly” in financial markets. There was no adequate risk-based argument for why momentum was present in market prices. However what they found was that prices of stocks that were going up tended to go up over a period of time, and prices of stocks that were going down tended to go down over a period of time as well. As such, the aggregate momentum of the overall market is something that we also pay attention to — if momentum was negative and below a certain threshold, then you can be sure that markets will be weak. At present, the data shows that the momentum in markets is still strong.
Therefore, the next time your portfolio takes a dip, don't panic. Instead, take a deep breath and recognise that this was always going to happen at some point. As of now, the current market signals tell us that if a correction were to occur, there is a good chance that it wouldn’t be of the magnitude that we witnessed in 1Q 2020. However, in investing, there is no such thing as 100%-sure probability. We have a wide range of portfolios designed to match a certain level of risk and return. As long as your portfolio was properly constructed in conjunction with fiduciary advice, you can choose to sit back and relax, allowing market events to run their course.
Whether your portfolio is on autopilot or you choose to handle the details yourself, the important thing is to concentrate on the things you can control, while doing your best to ignore the distraction of daily market noise.
