How falling markets present tough questions to investors

Thursday, Oct 25 2018 by
44
How falling markets present tough questions to investors

Share prices have fallen across the board in October, and it’s a reminder of just how quickly fear spreads when stocks start tumbling. My colleague Jack wrote this week about the sense of foreboding that’s hanging in the air at the moment. There’s almost a sense of inevitability that some kind of correction is past due. Knowing how to react to that kind of prospect is difficult.

Ten years into a bull run, and faced with various signs of trouble (in various parts of the world), it’s not hard to piece together a pretty gloomy narrative. While October has been unpleasant, some of the main UK indices - certainly the small and mid-caps - have been trending down since early summer. So for some investors, this experience has been less of a suckerpunch correction and more of a protracted beating.

This week the FTSE 250 has been flirting with correction territory, with the index currently down by just over nine percent for the month. As usual, the UK indices are taking at least some of their cues from price action in the United States. That’s been translating into some sharp and unpredictable intraday moves - days that start well but end up finishing on yet another low.

Profit warnings and bad news

In recent weeks the sharpest falls on the FTSE 250 have been exacerbated by bad news and profit warnings. Among the biggest fallers have been stocks like Keller, ConvaTec, Superdry, Indivior, Inchcape and Victrex. In terms of relative price strength, they’ve all undershot the All-Share index by more than 20 percent.

There are similar war stories over on the AIM All-Share, where Fevertree Drinks - a stock that, size-wise, has more in common with the FTSE 100, has seen more than a billion pounds wiped off its value since the end of the summer. It’s down from £4.23bn in early September to £3.18bn currently.

But it isn’t necessarily all bad news. It’s fair to say that some stocks (a minority) are holding up reasonably well under the conditions. But it’s also the case that investors with at least half an eye on value have been crying out for a meaningful correction for several years. For many, what we’ve seen so far won’t be anywhere near enough. As a result, we’ve…

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As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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73 Comments on this Article show/hide all

shipoffrogs 26th Oct '18 17 of 73

I always thought the 30 days of highest market gains occurred in crashes when the market was whipsawing and that they therefore fell right next to the 30 worst days.

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Nick Ray 26th Oct '18 18 of 73
13

The idea that you can sell near the top of the market and then buy back in near the bottom is a sort of "optical illusion". The market is just the aggregate behaviour of all of its participants. Given the same level of information available to all participants, if one participant can see that the market will fall and chooses to sell, then so can all the others. And in effect that is what happens in a crash. Everyone wants to sell but there are no or very few buyers.

Any argument that you could sell before a share dropped 50% implies that your trading decision is based in part on a knowledge of the future - which is of course impossible. And if you wait for the fall to start to sell, and wait for the rise to start to buy then you find that you will either be too late to make a consistent net gain, or you will be whipsawing in and out because near the decision point the signal keeps changing. Partly this is due to the natural properties of random processes and partly it is due to people trying to second guess where the market is going.

The only method which can work is to rebalance against a cash reserve. So when the portfolio value rises it is top-sliced to maintain the same split of stock:cash and when the portfolio value falls more shares are bought to again maintain the split. In theory this will return a gain of (1/2)sigma^2 (where sigma=volatility). Usually this is a small amount compared with the returns of the stocks in the portfolio. But when the returns are zero or negative and volatility is high, it can be a significant sum.

Here is a simple example of how you can fool yourself that you can "predict" the future. Consider this profit-and-loss graph:

5bd307f5d5decroulette.png

It looks as if you could use momentum to buy in just after the 1000 point and then sell when the momentum runs out just before the 3000 point maybe.

But in fact this is a simulation of 4000 spins of a roulette wheel, with a bet on a single number each time. There is no momentum. The past predicts nothing about the future at all, and in fact we know that if you continue betting you will gradually lose all your money at a mean rate of -1/37 per spin. So we are reading something in this chart which does not exist.

Stocks behave differently, but it is still the case that we read patterns using human intuition which simply do not exist when you try to analyse the data.

With stocks, and especially with an index, the underlying drift is positive. In other words if you just stay in the market then eventually you will emerge with more than you started. However, with stocks the probability distribution has "fat tails" (Taleb) and that means that there are no guarantees of any outcome (positive or negative) in any given time-frame. (So the drift is greater than zero as time tends to infinity, but infinity is a long way away.)

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herbie47 26th Oct '18 19 of 73

In reply to post #412404

Fair enough but there does seem some evidence that active traders are less successful than buy and hold ones. Take Minervini, he lost money for about 6 years.

How about the Fidelity survey that says women are better investors than men. Is that fake as well?

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m096146 26th Oct '18 20 of 73
2

In reply to post #412519

Nick,
I think you are mixing a set of random events up with a stock market/share trend. The latter is not random over a short time period ( very short periods yes). Investors take a view on the news flow and if it is predominately bad or thought to be getting bad/worse then some may sell. I would suggest at present that almost all metrics point to an overvalued market , largely driven by QE money whilst the global background is not good viz USA/vs China tariffs, ECB vs Italy budget, Brexit, Fed raising their rates- one could add to this list. Otherwise why the short selling?
You will never get the top nor the bottom but I think there is money to be made by cashing out/re-investing so long as you have a strategy. Several active fund managers I read have increased their cash holding lately with this in mind.

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davidtalbo 26th Oct '18 21 of 73
8

Herbie

Your comments about Minervini are somewhat misleading, As he makes clear, he lost money in the first 6 years of his investing career, when he was learning the ropes and making the mistakes that most of us made. Assuming the later figures are not misrepresentations (and they clearly were not when he became US Investing Champion), then his subsequent returns by active trading have been outstanding. For what it is worth, one piece of Minervini wisdom is that the stocks that hold up best in a bear market are generally those that lead out that market, by advancing early and with the greatest gains.

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timarr 26th Oct '18 22 of 73
2

In reply to post #412549

How about the Fidelity survey that says women are better investors than men. Is that fake as well?

You mean this one?

https://www.fidelity.com/about...

Probably not ... the clue being that you can find it when you search for it.

Whether or not it's actually robust is hard to tell. Generally the gold standard for research is peer review in a reputable journal. That's not perfect either, but it's the best we've got.

But I'm not quite sure why this is relevant to this thread?

timarr

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timarr 26th Oct '18 23 of 73
5

In reply to post #412604

Nick, I think you are mixing a set of random events up with a stock market/share trend. The latter is not random over a short time period ( very short periods yes). Investors take a view on the news flow and if it is predominately bad or thought to be getting bad/worse then some may sell.

I'm not sure what Nick is saying: that post is unusually opaque for him. However, it's not necessarily true that movements even in the short term aren't random. There's a lot a work now that suggests that investors can be divided into those that trade on information (aka value investors) and those that trade on the signal that the value investors generate (aka momentum investors).

At the beginning of a bull market value investors predominate and most trading is done on real information, even if it's the only the first or second order signals generated by that information. However, as the bull run builds more and more uninformed people are attracted into the market and eventually the noise they generate starts to swamp out the underlying signal. But because they don't really know what they're doing they're uniformly positive and keep on pushing the market higher.

At this point real information isn't really driving markets, it's the random behaviour of uninformed noise traders. Even experienced investors will follow the trend, reasoning that they know it's insane but figuring they can get out before it blows up. At some point the fake signal they're following starts to break down, usually as confidence is lost due to external events, and you start to see an uptick in volatility as uninformed investors trade in and out, following what is essentially random noise.

Eventually, of course, the whole thing blows up, because prices have become disconnected from reality and external events start to impact valuations. Uninformed investors chase the price down until they give up and, eventually, informed investors start to pick up the pieces again.

At the market peak there's always a reason why stocks are justified in trading at insane multiples - the popular one this time seems to be that the scalability of the internet makes normal valuation methods irrelevant. It's nonsense of course, but people will always retrospectively justify their decisions as logical regardless of their actual decision making processes. And, of course, brokers, investment houses and media will amplify this message because they're all incentivised to have people dealing.

Timing the top and the bottom is never possible: but the general shape of things is usually vaguely discernible.

timarr

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herbie47 26th Oct '18 24 of 73

In reply to post #412614

Yes it was the first 6 years, not meant to be misleading. I think most people would have given up by then. That's probably why most active traders lose money.

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herbie47 26th Oct '18 24 of 73

In reply to post #412614

Just to be clear what I meant was it's difficult to beat the market as an active trader, even Minervini took 6 years before he started making money. Most traders are not as good as Minervini.

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Nick Ray 26th Oct '18 25 of 73
1

In reply to post #412644

Nick, I think you are mixing a set of random events up with a stock market/share trend. The latter is not random over a short time period ( very short periods yes). Investors take a view on the news flow and if it is predominately bad or thought to be getting bad/worse then some may sell.




I'm not sure what Nick is saying: that post is unusually opaque for him.

Yes. I joined together two different thoughts and probably messed up my main point.

What I really wanted to focus on is the fact that the market is the aggregate behaviour of all the participants. So treating it as this passive thing which you can outwit by trying to time your interactions with it won't work. In effect every participant is trying to outwit the market and the market itself is what you get when you sum all those behaviours together.

I'm sure there is some kind of proof by contradiction you can create but I can quite work it out in a way which I'm happy with so I fell back on a simpler analogy based on a pure stochastic process. But I fully acknowledge that it is not really the same situation.

It is somewhat related to the idea of "efficiency" - the act of exploiting anomalies causes them to be arbitraged away. If you don't agree that the market is efficient you will try to find ways to exploit the inefficiency - such as by timing your trading. And in a sense you are right: it needs people reacting to possible inefficiency to remove it. On the other hand, if you do accept that the market is efficient (or efficient enough) then you look for ways that work with the market rather than against it. And that approach can work too!

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herbie47 26th Oct '18 26 of 73

In reply to post #412619

To answer your question about relevance how about this "What is it, exactly, that makes women better investors? One factor, Fidelity said, is that men are 35 percent more likely to make trades, which means that trading fees eat away at their portfolios more than they do women’s."

As this post is about investors behaviour I think it has some relevance.

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herbie47 26th Oct '18 26 of 73

In reply to post #412619

To answer your question about relevance how about this "What is it, exactly, that makes women better investors? One factor, Fidelity said, is that men are 35 percent more likely to make trades, which means that trading fees eat away at their portfolios more than they do women’s."

As this post is about investors behaviour I think it has some relevance.

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jonesj 26th Oct '18 27 of 73
1

In reply to post #412404

1 Fidelity run funds, investment trusts & some kind of platform business.
Now most platform businesses make money from customer activity.
Therefore Fidelity would have a financial incentive to deny there was any internal survey which found the inactive & dead customers outperformed the active ones.

2 As for the market correction, well, as always, the challenge remains to be to decide if this is one of those intra-year declines which provide a buying opportunity, or the start of a more major bear market.     The US market has certainly been on a high valuation and has been many years into the bull market.    Some emerging markets offer more reasonable valuations. 




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gus 1065 27th Oct '18 28 of 73
3

Intrigued, I did a bit of internet digging about the phantom Fidelity report into the success or otherwise of active versus “dead” investors. The consensus seems to be that it was an internal report produced in mid 2014 covering the period 2003 to 2013 which found that the best performing investors were either dead or had “forgotten they had an account” with Fidelity and that the report was discussed on Bloomberg Radio by, among others, James O’Shaughnessy in 2016. As such, it doesn’t appear to have been published or in any way scrutinised at anything approaching a scientific level.

On a wider level, there has been quite a lot of empirical work done to investigate the tendency towards “action bias” (ie the belief that doing anything is better than doing nothing) and this does seem to support the view that active traders tend to underperform the buy and hold-ers. Dan Crosby discusses the academic research from the likes of Vanguard, Meir Statman and Odean and Barber among others in his book “The Laws of Wealth”, which also covers and appears to confirm the alleged urban myth that women (both retail and professional fund managers) tend to out perform men. This latter point is attributed/correlated with a tendency among men to be over confident and over trade (and thereby underperform).

In the digging process, I did find quite an interesting piece from Fidelity (US based) suggesting a general strategy for investors. Whether you see it as Funds industry propaganda or useful advice, it’s possibly worth a quick read.

https://www.fidelity.com/viewpoints/investing-ideas/six-habits-successful-investors

Pretty simple stuff, but my take is that their suggestion is to stay invested rather than try and job in and out of the market (“time in” the market is more important than “timing” the market etc.). Presumably they make more money from the platform fee on balances than they do on account trading income!

Personally, I think Winnie the Pooh had some sage financial planning advice when he suggested “Never underestimate the power of doing nothing”.

Gus.

(Sorry - just read Post 14 from Howard Marx which corroborates my own digging).

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BH1991 27th Oct '18 29 of 73
5

In reply to post #412289

Hi andrea34l

Regarding Victrex (LON:VCT) , news isn't the only catalyst for share price movements. In market environments like this, human behaviour (emotions) is usually the catalyst for erratically falling prices. If you are a value/ fundamental investor then this is a golden opportunity because price is now disconnected from valuations/outlook.  As you suggest, companies are issuing positive trading statements so it's now your job to see if there is "value" in these stocks. 


"I feel a complete idiot that I didn't see this coming and sell out of some of my holdings - I may feel that many of my holdings are good companies, but to see so much wiped off the share price gives me an amount of sadness. I have been investing for quite a long time... and I never seem to learn :-("


A quality company does not always mean a quality investment. Regardless of what others think, price is king and where you enter and exit a stock will have a significant impact on your portfolio returns.

Furthermore, your statement above suggests you don't sufficiently manage the downside risk in your portfolio. I know stop losses cause much debate here at Stockopedia, but using a trailing stop loss has saved me once again from a market correction! 

I have locked in my gains and I'm now 100% cash, waiting for a reliable market bottom to establish.  The problem most people have now is that they need a bull market just to break even, as where people who used stop losses and now in cash, can enter the next bull market from a relatively unscathed position.

Have you read Mark Minervini's books? Even if you don't wish to trend follow like he does, the chapters on risk management are truly eye opening. It changed my approach and I'm now profitable as a result. The books are only c.£20-£25 on Amazon. Quite possibly the best investment I have ever made haha!

All the best!

BH

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daverawc 27th Oct '18 30 of 73
3

The argument that markets are efficient was blown out of the water decades ago by the likes of George Sros probably the best of market timers

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PhilH 27th Oct '18 31 of 73
16

Here's where I'm at.
My approach blends a high QM screen with technical analysis (specifically Ichimoku Clouds) to buy and sell. I invest in the UK, Europe & US with mostly smaller companies although I do buy some bigger companies too that match my criteria.

My strategy in market bumps has been to wait a while to let the dust settle before doing anything. In the past I've been fortunate that the market has rallied quite quickly and I was able to sell the stocks that didn't rally with it. But for me this time it feels a little different. 

I've been using weekly charts with Ichimoku Clouds to monitor each region. The logic for doing this is based upon noticing that the Chikou (or the blue lagging line) interaction with the Icchimoku Cloud (or Kumo) could be a good bull/bear indicator on a weekly S&P 500 chart. I've highlighted this with red circles below.

5bd43e0becbecsp500at.png


I use the same principle to monitor other indices using weekly charts


UK

FTSE 100 - Weekly Chart

5bd43c71e3631ftse100.png

The blue lagging line has broken below the cloud (historic price action). The actual close on Friday was 6949 so the updated weekly chart will look more bearish still.  For me this chart reads Bearish and would be strongly bearish if the price closes below the previous low in the spring of 2018.


FTSE All Share - Weekly Chart

5bd43edeaf548ftseas.png

Again the blue lagging line has broken through the cloud and the friday close was 3808 which again would make the weekly chart more bearish. For me this chart reads Bearish and would be strongly bearish if the price closes below the previous low in the spring of 2018.

FTSE Small Cap - Weekly Chart

5bd43f853cca2ftsesmc.png

The blue lagging line is stuck in the cloud and the cloud is thick as there has been consolidation and uncertainty over the proceeding weeks. The theory is that it is harder for the price action or lagging line to penetrate a thicker cloud as this indicates that there has been a big battle between the bulls and the bears and so the price tends to bounced off the cloud. In the end the price sank through the cloud as it thinned. Will the lagging line bounce of the bottom of the cloud as the price rallies or will it sink through the cloud. For me this chart is Neutral and I'd label this chart as consolidating. The actual Friday close was 5393 so the lagging line is still just about contained within the cloud but it's looking ominous.

Decision:  Close all UK stocks that have Q < 80 or M < 80 or having negative EPS upgrade estimates for FY or FY + 1 and I've opened a super short on the FTSE.


Europe

Dax - Weekly chart

5bd442a844c3bdax.png

Blue lagging line has convincingly broken down through the cloud and recent price action has closed below the lows in the Spring of 2018. Price close as of Friday was 11159 so the updated chart will be more bearish. For me the is a Strong Bearish chart.

FTSE Eurofirst 300 Excluding UK

5bd443805b4baeuro300exuk.png

Blue lagging line has  broken down through the cloud and recent price action has closed below the lows in the Spring of 2018. Price close as of Friday was 1614 so the updated chart will be more bearish. For me the is a Strong Bearish chart.

Decision:  Close all Euro stocks that have Q < 80 or M < 80 or having negative EPS upgrade estimates for FY or FY + 1 . Open a super short on the DAX.

US

S&P 500 - Weekly Chart

5bd4486a3560bspx.png

The blue lagging line is still well clear of the cloud despite the fact that Friday's close was 2661. The warning signs are there though. When the chart is updated to reflect Friday's close: the blue lagging line will probably have dropped below the historic price action; the fast moving average (orange line) will have pushed down through the slow moving average (red line) and the closing price on friday of price action in the last column will be sat smack in the middle of a relatively thin cloud (offering little resistance).

However, whilst the price action might well penetrate the cloud there is a chance that the lagging line will bounce off it over the next few weeks as the price rallies under the cloud. I wouldn't be surprised if there is another rally before it turns bearish. Perhaps a head and shoulders pattern or a triple top.

At present I'm neutral on this chart.

S&P 600 Small Cap - Weekly Chart

5bd44b2e3b7e2spxsc.png

The blue lagging line is still well clear of the cloud despite the fact that Friday's close was 934. Again the warning signs are there. When the chart is updated to reflect Friday's close: the blue lagging line will be below the historic price action; the fast moving average (orange line) will have pushed down through the slow moving average (red line); both moving averages are heading south and the closing price on friday of price action in the last column will be sat smack in the middle of the cloud. Again I think there could well be a rally here before, if any fall below the cloud occurs. 

Again I'm neutral on this chart.

Decision:  Close all US stocks that have Q < 80 or M < 80 or having negative EPS upgrade estimates for FY or FY + 1.  No short on the index at this time.

Other things that are making me twitchy.

US midterm elections are currently showing unprecedented early turnout. Historically this tends to indicate that the vote will be stronger for Democrats. This could mean they take the House. This will make things tricky (trickier) for Trump. Greater uncertainty for US business. Trade wars, etc. etc.

UK/Europe - BREXIT chaos. For UK uncertainty over future Labour/Tory/Coalition government and implications for business. 

Currently I'm 30% Cash, 11.5% US stocks, 19% European stocks, 3.5% UK stocks and 28% shorts on DAX on FTSE (but theses super shorts so 2x)

Best of luck everyone
Phil

Professional Services: Sunflower Counselling
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daverawc 27th Oct '18 32 of 73
3

As for the buy and hold argument, if you had bought the FTSE 100 in late 1999 early 2000 you would have suffered 18 years of negative returns up to today.

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herbie47 27th Oct '18 33 of 73
1

In reply to post #412779

I don't think so because that ignores dividends, but why cite just the FTSE 100, there are many other shares to buy. The FTSE 250 has done better. Anyway you just looking the average ex. dividends. I believe the FTSE 100 average is about 8% pa inc. dividends, not great but not negative.

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herbie47 27th Oct '18 33 of 73

In reply to post #412779

I don't think so because that ignores dividends, but why cite just the FTSE 100, there are many other shares to buy. The FTSE 250 has done better. Anyway you just looking the average ex. dividends. I believe the FTSE 100 average is about 8% pa inc. dividends, not great but not negative.

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