Current market volatility and resulting portfolio decisions

-->

8th Feb '16 by AnonymousUser39114

33 comments 12593 reads

Hi

My position is that I am fully invested in quality equities, but not geared and able to sit on my current holdings for the next decade or two.

The current market volatility leaves me confused, because the correction seems a little overdone based on historic valuations. However, I feel like I should be doing something to protect my capital.

Possible options seem to be;
* do nothing and sit it out
* reduce the higher pe valued companies and hold cash and/or
* short individual shares.
* short the indices and continue to hold current positions.

Would I then be doing something for something's sake, if I believed in these companies and have no pressing need to realise them?

Did I miss any possible options?

Any help appreciated....

Unlock with Email

Unlock with Google

Already have an account?
Login here

About the Author

AnonymousUser39114

Premium Member

33 comments

cig

9th Feb '16

If you short now, and there's a steady rebound, you may end up losing money while being right on the fake correction aspect. Being right and out of pocket can be quite frustrating!

(I happen to agree that it's probably a short term tantrum and I'm happily sitting on my hands. More generally, when facing tricky investment choices, I try to minimise expected regret: pick the option where being wrong will hurt the least.)

AnonymousUser39114

9th Feb '16

Thanks, both. Very helpful comments.

Ok, no shorts!

At the risk of sounding like a trader (euch!!) I think I am going to sell shares on any seemingly decisive 30 day + 3 month moving average crossovers (I.e those whose sharr price declines appear to have momentum rather than flatlining, to avoid whipsaws) and park this cash until the reverse happens.

This policy may well cost me money in but this seems (to me) to be the equivalent of an insurance premium against the current downwards momentum? Also it is reassuring to have an objective rule, I think?

AnonymousUser39114

9th Feb '16

Sorry for the typos. Fat fingers and small phone!!

TangoDoc

9th Feb '16

Has anyone else ever wondered where the money they lost actually went? ( Apart from recesses in brokers' trousers, of course). When the UK housing market fell and so many people I bumped into had "negative equity" (actually, only LESS equity than they would have liked, most of the time) I never felt the slightest anxiety because I was happily living in my house, one I'd selected for its living qualities, not its investment potential. I last moved house in 1983, propose to die in it, so the fact that its value came back up and is now a "ten bagger" only has relevance to those in my will since it is still the good place to live that it always was. For a benign happy philosophy of investment, that takes a bit of beating, I'd say.

vik2001

9th Feb '16

if you look at whats happning, we are getting drops in the ftse followed by small rebounds. these rebounds are the reason not to panic sell. as long as the small rebounds keep occurring do not panic. panic will occur most definatley when there are no rebounds taking place. but its so hard to figure out which ways the markets keep turning, now its the banks causing the issues..

mrwhits

9th Feb '16

@vik,

sounds like death by a 1000 cuts to be honest.

I'm net short at the moment with US companies, with long positions in gold and silver, as follows,

US stocks - short
atvi , chdn , fizz , kr , manh , mco , nflx , panw , stz

longs,

US and CA -
clf , fcx , bsx , gdxj , paas , jgbd

UK based,
paf , phau($) , golb

doing OK YTD and hoping that there is more of the same, i.e. market turmoil, US bear market , gold rising, that's the trading theme of it all.

It might go horribly wrong, but to be honest, after nearly getting wiped out in 2007/8/9 by being long only UK stocks , this time had to be different, so a mix of long and short it is. I dont want to experience a -39% year followed by a -46% year again thank you.

Longer term, who knows, this is for the next 3 to 24 months.

I do think we will see a severe and shocking(to some) bear market in the US markets some time in the next 18 months, and hope people realise this and change as no one wants to see anyone wiped out by a bear, because I can't see why the price of shares will go up any time soon, due to a lack of growth in the US, the junk bond markets failling, the real interest rate in the US being negative, no more cheap money(for now) from the US that allows corporations to buy back stock cheap to inflate EPS to keep share prices high etc etc etc, there are just so many reasons for a fall, and not many for a rise IMHO.

So I think even if you didn't want to/dont know how to short, cash would be better than a -BIG% !

Just my 2p.

Regards

mgallear

9th Feb '16

We appear to be in a bear market with the strong possibility that the global economy is going into recession. This seems to be worse in emerging markets such as China. It is unclear if the US and UK will technically go into recession or just slow down (the soft landing.) This appears to be part of the natural seven year recession cycle but some analysts also think we are near the bottom of a much longer commodity super cycle. Basically, China which bailed out the world economy in 2009 by stockpiling commodities is now shifting to a more service style economy. This change is likely to be very painful in certain industries in China and disruptive to the rest of the economy. There does not seem to be much admission in the markets so far that we are in a global recession and until that happens the market is unlikely to start thinking about how good the recovery is going to be. Of course, this could be an overreaction by the market and just a dip such as the market reaction to various global life threatening viruses that magically disappeared. It does not feel like such a dip to me.

I personally don’t like the idea of shorting for any length of time and you could end up losing money on the up trends or rebounds after a sharp fall. If you hold your shares in an ISA it will probably not be easy to do. There may be certain ETFs that will allow you to short a market index but will your provider let you buy them?
It is not easy to predict what will fall next as oil shares seemed to have bottomed for now but commodities are still falling and shares in general or just falling as the fear of recession and the fall of in cooperate earnings have fallen. Are we near the bottom or will the correction take us from 2014 to 2011 or 2009?

There are no easy answers. Stop losses will mean you will lose some money now but allow you to fight again another day. If you are still up 20% then setting a 10% stop loss is not psychological too bad. However, you could find yourself automatically selling at the bottom of sharp and short fall and be looking at your sells when a rebound has taken the market back up. If you don’t and try and wait it out you could see your losses increases much further and find yourself stuck in shares with little chance of going back to where you originally bought. Some investors sell after the rebound and then switch to shares with a better chance of recovery hence causing market recovery’s to falter. If you set a stop loss do not do it too far down as your intention must be to get out of a share with the intention of buying it or another share after the fall has stopped and recover is on.

I think you have to have some money in reserve to take advantage of the final recovery, if you don’t then set those stop losses or look at once favourite shares that are now on the way down and sell them and wait.

Mark Simpson

9th Feb '16

BEN12358,

I think the real question is why you are worried about market volatility? It is both to be expected and assuming you are a private investor with a long term investment it is not a risk to you. You will not be fired for several years of under-performance.

That you are worried means one of several possible things:

1. Your asset allocation is mismatched compared to your investment timeline. i.e. you are investing in the stockmarket with money you will need in the short/medium term.

2. You are not confident in your stock picks.

or most likely...

3. Your temperament is not well suited to your current investment strategy.

What to do depends on which one it is.

1) Sell enough to raise your short term cash needs.

2) Sell the companies that you have lost confidence in even if it requires taking a loss.

3) You can either change your temperament or change your investment strategy.

Your temperament is probably best changed by reading about the historic out-performance of your chosen strategy (papers by Cliff Asness or books detailing the work of Buffett/Munger would be a good start for a quality based investment strategy) or assessing and confirming the economic moats that your quality companies possess through a thorough review of their business models & financial metrics.

All the options you mention are essentially ways to adapt your investment strategy. The easiest to implement is holding more cash/government bonds the hardest to implement (at least successfully) is shorting individual stocks. Although a portfolio decline can be a good call to action any change of investment strategy should be permanent. So if you decide that holding high P/E stocks no longer fits with your strategy then you should keep this rule in the next bull market and not go back to chasing highly priced stocks. Otherwise you are simply gambling on the overall direction of the market rather than pursuing a long term strategy.

Good luck whatever you decide.

AnonymousUser39114

9th Feb '16

Thanks everyone!! It reallly is more of an art than a science! So many different intelligent approaches.

For me, I am confident in my stock selections, which are investments for the long term and I don't need them for living costs... However I am not confident in the short term rationality of the market with the Brexit looming, and I don't believe we have seen the final capitulation phase of the correction as yet. This pushes up this risk premium for me personally.

Accordingly , I am going to let the market take the lead and use moving averages to exit, hold cash and use them for re-entry.

Good luck all.

Ken Lowes

9th Feb '16

My views of the current market which were first expressed in early January and prior to current market activity. I expect a further 20% fall FTSE 250 but if you are long term then you should do nothing. Selling now gives you a further headache of buying back. If you hold quality turn off the screen and come back in a couple of years .

pka

9th Feb '16

Underscored wrote:

"This maybe of interest, a review of "dual momentum" strategies. Only stay in shares whilst the trailing 6-12 month absolute returns are positive. http://awealthofcommonsense.com/2015/07/my-thoughts-on-gary-antonaccis-dual-momentum/ "

Gary Antonacci, the originator of the 'dual momentum' strategy, recommends staying in ETFs tracking stock markets if the trailing 12 month absolute returns of the relevant indices are positive, and being in bonds at other times. There is more information about his strategy on these web sites:

www.dualmomentum.net
www.optimalmomentum.com
www.optimalmomentum.com/RiskPremiaHarvesting.pdf

I think Antonacci's strategy has a lot of merits because it reduces the risk of being fully invested in equities during prolonged bear markets. However, it is not obvious to me how one could apply it to a portfolio of individual shares. For example, if one sells all the shares in one's portfolio every time the FTSE All Share Index is below its value a year earlier, and buys them all back whenever the index is above its value a year earlier, one would incur a lot of transaction costs and aggravation, not to mention Capital Gains Tax if one's portfolio is not in an ISA or SIPP.

After some thought, I have had the following idea of combining some of the ideas of Dual Momentum with a Stockopedia 'farming' approach to portfolio management. My idea is to create a Stockopedia screen in which the selection criteria are StockRank > 80 and '% Price Change 1 year' > 0, and which sorts the stocks satisfying the criteria in the order of decreasing '% Price Change 1 year'. One could then use the resulting list of stocks to create a portfolio using one's preferred approach for portfolio selection. For example, one could use Ed Croft's 'Naps' approach of working down the resulting list to buy 20 stocks, such that there are no more than 2 stocks in each sector and just one stock in each industry group. If it is not possible to buy 20 stocks by following those rules, for example if there has been a major bear market and very few stocks have prices higher than a year earlier, then one would allocate 1/20th of the portfolio's total value to each individual stock purchased and use whatever money remains to buy a low-risk asset, such as a fund investing in short-dated gilts, a 'targeted absolute return' fund, or a multi-asset fund, or just leave the money in cash. Once a month, one would check the portfolio and sell any stocks whose '% Price Change 1 year' is negative or whose StockRank is significantly below 80, and then follow one's preferred rules to reinvest the proceeds of that sale in another stock using the same screen as before.

I think this idea may have some merits, because it is not a pure momentum strategy, as it restricts itself to stocks that have StockRanks greater than 80, which means they must have reasonably high Quality and Value Ranks as well as reasonably high Momentum Ranks. But it also uses ordinary momentum, because it orders the stocks by decreasing percentage price change over the previous year. It also uses absolute momentum, because it forces one to sell any stocks that have prices lower than a year earlier, and this is a bit like a 'stop loss' strategy. I think an advantage of this approach is that it not an 'all or nothing' strategy, because it would not take one completely out of equities as soon as the index is below its level a year earlier and back into equities as soon as the index goes above its level a year earlier. A possible disadvantage of this approach is that it might lead to a lot of trading of individual stocks and therefore highish transaction costs.

I would welcome other people's thoughts on this idea.

Mark Simpson

9th Feb '16

Although momentum works for individual stocks, trend following has some issues. See the analysis of a simple moving average strategy here:

http://www.philosophicaleconomics.com/2016/01/movi...

(1) For a given risk asset, at the end of each month, check the closing level of the asset’s total return index. (Note: you can quickly derive a total return index from a price index by subtracting, from each price in the index, the cumulative dividends that were paid after the date of that price.)

(2) If the closing level of the total return index is above the average of the 10 prior monthly closing levels, then go long the asset and stay long through the next month.

(3) If the closing level of the total return index is below the average of the 10 prior monthly closing levels, then go to cash, or to some preferred proxy for a safe asset, and stay there through the next month...

...The performance is excellent in all categories except the individual S&P 500 stock category. Importantly, the excess Sortinos for foreign equities and global currencies are firmly positive, confirming that the added return is making up for the larger-than-expected excess drawdown and lower-than-expected drawdown win percentages noted in the previous table.

The strategy’s performance in individual S&P 500 securities, however, is terrible. In 4 out of 5 individual S&P 500 stocks, the strategy produces a Sortino ratio inferior to that of buy and hold. This result again tells us that on the criterion of risk-reward, the strategy’s timing performance in the category is worse than what random timing would be expected to produce.

It might seem counter-intuitive that a moving average strategy can perform on indices but not on the securities that make up that index. The following piece explains this paradox.

http://www.philosophicaleconomics.com/2016/01/gtt/

So I would be very wary about implementing any strategy on individual shares that has not been directly tested on those even if it has worked on indices or ETF's.

TangoDoc

10th Feb '16

While all the different mathematical wheezes that have ever been proposed are fascinating, they do all suffer from the effect of being wisdom after the event, they need a vast amount of work and, in any case, come with the same guarantee we all get when we buy positions in any company.
I am of the identical view as Danger; volatility is normal. It's a physical certainty, just like gravity. I am reminded of watching guys constantly changing lanes on busy motorways, imagining that by increasing the risk to their very lives, they are saving time when, by interrupting the sweet flow of traffic, they are slowing the totality by creating bunching. I understand that if you want to get the maximum numbers of vehicles safely from London to Edinburgh, they should all travel at something like 27 mph. Hah!
I prefer to avoid being deluded into thinking I am an investing genius. Most of us have neither the brain, the information, the time or the sheer luck to play the market like a video game so we are doomed to travel steadily up the middle lane. I quite like it and I get there in one piece.

pka

10th Feb '16

Hi DangerSimpson, Thanks very much for your response to my post.

I've just read the two articles you gave links to, and I think they're both excellent and fascinating articles. However, I don't think they refute my idea for an investment strategy, because they state that a strategy of going long on an individual S&P 500 stock if its price is above its 10-month moving average, and going into cash at other times, gave poor results on average. They also state that strategies based on 12-month momentum, i.e. going long on a stock if it is above its price 12 months earlier and going into cash at other times, gave very similar results to a strategy based on a 10-month moving average. But my idea is to do something that is subtly different from those particular strategies.

Many other published studies have shown that strategies based on the 'relative momentum' of individual stocks have tended to out-perform the stock market index over the long-term. For example, a very simple 'relative momentum' strategy is to buy a portfolio of the 20 stocks in a particular stock market index (such as the FTSE 100) that had the best relative share price performances over the previous year, hold them for 6 months, and then sell that portfolio and repeat the process each 6 months. (If all their share prices are lower than the previous year, one would buy the 20 stocks with the smallest percentage falls, because this is a 'relative momentum' strategy.) According to this web page:

http://www.independent-investor.com/articles-by-markets/equity-markets/the-mystery-of-momentum/

that simple strategy produced a cumulative out-performance of several percent per year over the relevant index, although there were some individual years when it significantly under-performed the index.

A simple combined 'relative and absolute momentum' strategy applied to individual stocks would be to buy a portfolio of the 20 stocks in a particular index that had the greatest percentage share price INCREASE over the previous year. If there are fewer than 20 stocks whose share price is higher than a year earlier, then one would buy each of those stocks with 1/20th of the total portfolio value and leave the remainder of the portfolio in cash. One would repeat this process once each year. I have no evidence to support this, but I suspect that this simple combined strategy would perform better on average over the long-term than the simple 'relative momentum' strategy I described above. This is because one is still buying the stocks with the highest relative momentum, even if there are fewer than 20 stocks whose share price is higher than a year earlier, but one would tend to be mainly in cash during prolonged severe bear markets, which is one of the claimed advantages of Antonacci's 'dual momentum' approach.

Stockopedia's Momentum Rank does something much more sophisticated than the above simple 'relative momentum' strategy, so one would hope that it would perform better on average over the long-term. The QVM StockRank combines Quality, Value and Momentum Ranks in a single rank, so one would hope that a strategy based on the QVM StockRank would do even better on average over the long-term than one based on just Stockopedia's Momentum Rank.

My idea is to have a strategy based on the top two deciles of the QVM StockRank (i.e. those stocks with QVM StockRank values greater than 80), add some diversification by not buying more than two stocks from each stock market sector and not buying more than one stock from each 'industry group', and also add a combined simple 'relative momentum' and 'absolute momentum' filter to them. My hope is that such a filter would improve the risk-adjusted long-term performance of the strategy, although of course I have no evidence for that.

Ken Lowes

10th Feb '16

Tango, that's three points for traveling up the middle lane!!!!

Mark Simpson

10th Feb '16

Hi pka,

I agree with your comments on momentum however (and we have probably already become too 'quant' to help the OP with their decision making :-) a momentum strategy of buying a set of stocks that have gone up the most and shorting those that have dropped the most on a 6-12 month formation period is completely different to applying a rule of 'Only stay in shares whilst the trailing 6-12 month absolute returns are positive' amongst existing holdings chosen based on quality metrics.

Yours is a method for picking stocks, Underscored's suggestion was a way to manage a portfolio of existing chosen stocks.

Just because the former works does not mean that the latter works. And even evidence that the latter works on indices is not enough to show that the latter works on individual shares. Which is what the articles I linked show.

I think your strategy could well be sound (all be it probably highly exposed to momentum since it is on the QVM rank and in your additional filters) it's just a different strategy to that suggested by Underscored to the OP. The 'Only stay in shares whilst the trailing 6-12 month absolute returns are positive' strategy could well be a dangerous one since it is pretty similar to the one tested in the links that have Sortini's worse than chance.

Cheers,

Mark

TangoDoc

10th Feb '16

No, that's lane HOGGING and actually applies to any lane and has so far usually been applied to vehicles going too slowly for the traffic conditions. (The first person ever convicted was travelling at 60mph). It is unlikely to be considered an offence for a driver to stay in a middle lane at 70mph but it would certainly be, technically, an offence to overtake him and could even be considered dangerous driving, under section 2 of the 1988 Road Traffic Act, to undertake. In any case, the law requires the discretion of the police officer who would be obliged to follow such a vehicle a considerable distance before deciding there was an actual offence being committed worth the hassle. All good fun!

pka

10th Feb '16

Hi DangerSimpson,

Thanks for your comments on my posts. I think you made some good points.

jonno

11th Feb '16

The maxim 'the time to buy something of value is when nobody wants it' comes to mind'. Insofar as equities are concerned it is an approach I try to adopt, although not always as successfully as I would wish. To my mind there are two aspects to the conundrum; identifying the value and timing the purchase. Unfortunately a stock that is good value on all accepted metrics may continue to fall. As has been said before no one blows a whistle when the bottom is reached so trying to time a purchase on the basis that the price has bottomed is usually fruitless. In a falling (bear) market my approach is to add to existing holdings when I feel that the price has been unfairly beaten down. To free up funds I will take a profit on stocks where I think that the value has generally be realised. Other than this tinkering around the edges I will sit on my hands.

AnonymousUser39114

11th Feb '16

Thanks Jonno,
- I do think facing the grizzly bear head-on will almost certainly win in the very long run, so good for you!

Further, I do appreciate it's very true that successful investors such as Lord Lee of Trafford may elect to hold onto their investments during a general market correction.

Having said this, a question I am pondering is if there is any difference between catching a falling knife (which I never do) and holding onto a falling knife? I also ponder John Murphy's writings on technical analysis which suggest it may be possible to dissect the life cycle of the current bear market, which would give me my whistle..

Maybe the decision to hold a portfolio throughout a bear market or to 'hold cash or short the market' is down to whether you believe the theory of technical analysis is sound ((based on human psychology which will not change), or not?

Unlock the metrics for all these stocks and more...

Take a free trial

Facebook Twitter Youtube Instagram RSS

This site cannot substitute for professional investment advice or independent factual verification. To use it, you must accept our Terms of Use, Privacy and Disclaimer policies.

Unlock the metrics for all these stocks and more...

Take a free trial

Current market volatility and resulting portfolio decisions

Unlock the rest of this article with a 14 day trial

About the Author

AnonymousUser39114

33 comments

Unlock the metrics for all these stocks and more...

Unlock the metrics for all these stocks and more...