Thru Thursday February 8, the S & P 500 was down in seven of the last nine trading sessions, including one day drops of 4.1% and 3.8%. Following Thursday’s (2/8/16) close, the market was down 10+% for the year, marking the first correction in over two years (a correction is a 10% drop in the stock market). Americans tend to have short memories when it comes to market pullbacks, but it is important to remind everyone that these are normal and healthy for the stock market.
The stock market is reactive, not predictive, to events. So, what events are responsible for the recent correction? I attribute it to a fear of rising interest rates, a potential government shutdown, and the DACA issue. Perhaps the most important factors are the “programmed trades” used by large traders, i.e. institutional investors. When the stock market drops a predetermined percentage, the “programmed sells” kick in. Because the large traders control so many shares of stocks, these “programmed sells” can have a significant impact on the stock market*.
It is important not to panic and stay the course. With the extreme volatility we have seen this month, it is easy to get “whipsawed” by panic selling. For example, let’s say that you panicked and sold on February 8th when the market was down 10% for the year. Let’s look again at the impact of the large traders. Just like they can move the market down by selling millions of shares, they can also move the market up by buying millions of shares. The market was up nearly a combined 1000 points on Feb 9 and Feb 12. By selling, you would have missed the nice bounce back. That is the definition of getting “whipsawed”.
How do we at Buetow Asset Management play this volatility?
- We don’t panic. A correction presents us with a buying opportunity. Generally speaking, a 10% drop in price is a buying signal to increase the position size of our core holdings.
- As you are already aware, protecting my clients’ downside risk is extremely important. I utilize a strategy called “stops” which is similar to the big boys’ use of “programmed trades”. In most cases, these stops are set at 20% off of the security’s 52 week high. For instance, if the 52 week high of ABC Company was $100/share, we would sell ABC Company at $80/share. Because I don’t control many millions of shares, my trades have little or no impact on the stock market
- Finally, our portfolios hold a fair amount of Cash and Cash Alternatives which are not susceptible to the volatility to the stock market.
Please call me if you have any questions about your portfolio.
* These are the opinions of John Buetow and not necessarily those of Cambridge, are for informational purposes only, and should not be construed as investment advice.