Markets and Weather Can Both Change Quickly

02.15.2019

Greetings & Happy February.

As this is written it is Super Bowl Sunday. It is also sunny and 60 degrees outside. Rewind four days and we were in the middle of a Polar Vortex. In four days we’ve moved +100 degrees. Truly amazing.

In many ways, the December panic in the stock market was similar to the weather of late. We had a very atypical (for December) meltdown to finish the year. Fast forward a month and the markets have enjoyed a sharp rebound as the S&P500 was +8% in January. Markets often act irrationally: December seldom brings losses in the stock market, and very rarely is the S&P500 up 8% in a month. The key is not to overreact to these extremes on either end.

In this note we’d like to review how and why we at LJI look to take advantage of the market extremes mentioned above.

If we rewind to fall 2018, the news flow was terrible. The markets topped out in late September, and October brought a rough selloff. Let’s call these sharp pullbackspanics’. When investors panic, they sell. Selling begets more selling and, quickly, the markets are down 10% (thru mid-October)while the financial media is searching for any/every reason. Throw in never-ending political turmoil and the fact that bad news sells…and the masses get scared. And, well, you know the cycle.

Please keep in mind we realize a panic in the market is never fun. In fact, they’re downright scary most of the time. We respect the headlines and we certainly understand your concerns in the moment. The goal isn’t to never sell and lower exposure to stocks…the goal is to NOT sell into a panic. If you recall we sent a note on December 21st (link here) in an effort to keep things in perspective. We never want to see a client sell at panic lows.

How can we tell if we’re in a panic? As we typically mention we track many technical (think: stock charts) and sentiment (think: Fear vs. Greed) indicators to evaluate market health and opportunities.When fear readings are extreme AND there is significant technical damage, THAT is when we look to buy. But, in the moment, when those two wonderful scenarios line up, we also recognize the need to reassure you the world isn’t ending and, at the very least, prevent you from selling. So, we tend to reach out and explain why NOT to sell during those panics.

As mentioned in that December newsletter, long-term investors and institutions LOVE market panics. You can call them pullbacks, corrections, bear markets, etc. The bottom line is they’re opportunities. We look forward to them and you should too.

Typically, during a panic, we get a few clients asking us “Should I sell everything?”. To be clear, we NEVER believe that is a good idea. We will never recommend that as a prudent solution. We believe you should never consider it either. Capitalism works. Volatility will always exist. Weplan for volatility and take advantage of it. We have sold bonds and bought stocks across our core accounts during the following ‘panics’: August of 2015, Feb 2016, Nov 2016, Feb 2018, Oct 2018, & Dec 2018. In each of these panics Fear readings were extreme and technical indicators showed ‘washout selling’. We believe the most important duty we have as investment advisers is to keep you invested (over time), at the very least. The hardest part once someone has sold everything is deciding when, and how, to get back in.

Let’s rewind again to December, the week before Christmas. The Federal Reserve did something they haven’t done in over 40 years. They raised rates when the stock market was down over 10% from it’s highs. That was Wednesday afternoon at 2 pm. The Dow Jones Industrial Average (DJIA) immediately rose 300 points and then dropped by 900 points by the close. The next day it fell another 500 points. We were on track for the worst December since 1935. That’s 93 years. “Worst December Since the Great Depression” is what the headlines said. China was slowing, the government was shut down, interest rates were going up, a recession was imminent, tariff talk was everywhere, tax loss selling was rampant, the bull market was over, Apple & Amazon warned about a tough 4th quarter, and even Santa’s sled was broken. Fear was EXTREME.

What did we do that day?On December 20th, in our most conservative accounts, we adjusted our portfolios and increased equity exposure.  In other words, we sold bonds and bought stocks. Similar moves were done in our more aggressive accounts in both October and in mid-December.

The next day we sent out our December newsletter and the DJIA fell another 480 points. The next day, Christmas Eve, we fell 600 points. Finally, on December 26th,buyers showed up. That day was the first time the DJIA had ever rallied by over 1000 points in a single session. The rest of that week the market continued to climb…and the world didn’t end. We still enjoyed the worst December in 93 years. But smart investors and institutions continued to take advantage of lower prices in January and…we had the best January in over 30 years.

That’s how markets work. They overshoot. Why? Very simply because emotions take over. A horrific December is followed by the best January in 30+ years. The key is not to panic. That is also why we believe in owning some bonds or cash (‘dry powder’) to take advantage of these panics.

The point here isn’t to say ‘look at us, we’re market timers’.  The point is to help you understand our process/methodology a little better.  And it’s much easier to walk thru now vs. when we’re in the middle of a panic selloff.

One final thought. In the depths of a panic (trust us, there will be many more), it is extremely important to recognize that not every panic is 2008/2009. Nor the 3-year bear market from 2000 thru 2003. Those were both 50%+ pullbacks. There have been 4 of those in 100 years. They’re rare. Panics of 5%, 10%, 20%, 25% are very normal. We welcome them. You should too. They help us make money over the long-term.

THANK YOU for weathering the panic last quarter. And THANK YOU for allowing us to help you. Please never hesitate to reach out with questions or concerns.

Sincerely,

Your LJI Team