FOMO and Market Dips

Guest post by Michael Wagner

“Buy the dip.” Even those who are only somewhat familiar with the stock market have likely come across this advice. The logic is simple. Over long periods of time, the stock market tends to “go up”; over shorter periods of time it can and frequently does “go down”; and the lower one’s entry price, the greater the gains experienced when the market goes up. Everyone likes a deal, and “the dip” is the stock market equivalent of a discount sale. Or so the wisdom goes.

In all the talk about “the market”, from blogs like this one to the Wall Street Journal to Fox Business channel, it is sometimes easy to lose sight of what the market really is. In short, it is a group of investors, some individuals and some working on behalf of others, buying and selling securities (stocks, bonds, mutual funds, ETFs, etc.) amongst themselves. That’s it, just a group of humans trading with each other, each trying to secure the right investments for the best price. As with any group of humans, then, there are mistakes, failings, and frailties in the midst of all this activity. The study of these shortcomings is the subject of behavioral finance.

One of the most well-documented investor phenomena in the behavioral finance literature is a concept known as herding, which is the tendency of investors to follow the trend, whatever it is, due to lack of knowledge or perhaps due to “FOMO”—the fear of missing out on the latest rally. When inserted into this crowd mentality, a concept such as “buy the dip” can initially have a somewhat counter-intuitive effect. The more investors conditioned to buy the dip, the more buyers there are to step into even fairly minor selloffs, keeping the “bulls” fat and happy. Not a bad thing, right?

Before you buy the dip, though, you might want to consider this: why is “the market” (specifically the stock, bond, mutual fund, ETF or other financial instrument of interest) on sale in the first place? It could be that the seller has incorrectly decided his piece of the market has become overvalued or perhaps he just needs some cash. On the other hand, he could be right in his assessment that the risk of holding the security outweighs the benefit of continuing to hold it.

In today’s world, there are a number of significant risks of which to be mindful. Yes, North Korea has a history of crying wolf, but if you remember the story, the wolf does eventually come. How about the “Trump bump” that sent markets soaring after the election on expectations of significant healthcare and tax reform and increased investment in infrastructure? President Trump unexpectedly cut a deal with the Democrats this month to fund the government for a short while longer, but at some point investors are likely to give up on their hopes for and promises from an Administration that seems unable to whip its Congressional majority into working order. This week the Federal Reserve tipped its hand that interest rates might rise before year end. Central banks around the world, including the Fed, are indicating that they may start soon to gradually tighten their easy money policies after a decade of flooding global financial markets with liquidity. We all know what this liquidity has done for markets. While there continues to be a notion in the popular financial press of growing economies, soft economic data both in the United States and abroad leaves room to contemplate less optimistic assessments of global economic strength.

These are but a few of the many complex dynamics that investors must grapple with, and while they are varied in the type of risks they present, they each share a common element: they are incredibly complex issues and are extremely difficult to measure accurately as they relate to the stock market. Circling back around to behavioral finance, research has found that because such risks are difficult to isolate and measure, investors ignore the risks in favor of, you guessed it, the prevailing trend, simply because it’s easier and it supports their comfortable worldview. Unfortunately, ignoring risk because it’s easier is not a strategy that is likely to end well. Just ask anyone who bought a house in ’05-’06.

Buying the dip can result in picking up a good bargain, but before you do, make sure you’ve considered the following questions:

  1. Besides “the dip”, why do I think this is a good time to buy?
  2. What kind of risk exists in my portfolio right now?
  3. How much risk will I be adding to my portfolio by buying this dip?
  4. How will I respond to new developments in the stock market, economy, or geopolitical landscape that will significantly impact my portfolio? In other words, do I have an exit strategy as well as an entry point?

After doing so, you might find that you haven’t discovered such a great deal after all.

Scroll down and leave us a comment or question. We read every one.  Also consider sharing this post with your friends, they may thank you.

September 21, 2017

 

Hackquifax

Steps you can take now to protect yourself

As you are probably aware, 143 million Americans had their credit report stolen by hackers who infiltrated Equifax, one of the three credit reporting agencies. I think it is wise for you and me to assume that our personal information was among the stolen data.

If you have never looked at your credit report, you are not alone. If that is the case, now is certainly the time to do so. At a minimum, take advantage of the once a year free credit report. You need to know that your report contains the most intimate details of your financial life. The Equifax hackers likely stole social security numbers, birth dates, current and prior addresses, perhaps driver’s license numbers, and even nicknames.

In short, the stolen information is enough to impersonate you. I regard that as the chief risk from this attack. The hackers themselves are likely to sell your data to other criminals who want to do just that.  The criminals can then open new accounts in your name, obtain a driver’s license, or worse.

There are steps that we believe you should consider taking now.

1) Freeze your credit with all three credit reporting agencies:

Equifax                866-349-5191                 www.equifax.com

Experian              888-397-3742               www.experian.com

TransUnion        888-909-8872               www.transunion.com

Each of them has a slightly different process for implementing the freeze, and you must do it with all three. The downside to a freeze is that you will need to have the freeze lifted if you apply for new credit.  Keep in mind that it may take a few days for a request to lift the freeze to become effective.  There may be nominal fees associated with this service, usually $5-$10 each time you put it on or have it lifted.

2) Put fraud alerts on your credit bureau accounts.

This can usually be done directly with one of the reporting agencies, and I have been told by an Experian rep that putting it on one bureau will spread it to all three.  It is free but is only good for 90 days before it has to be renewed.  The fraud alert works differently than the freeze or other monitoring services. The credit bureau will notify the credit issuer that a fraud alert exists. It is up to the creditor to take further action.

3) Utilize a membership Credit Check & ID monitoring service.

Equifax is offering their service for free for a limited period due to this breach. Originally, they required customers to waive legal rights to sue, but that has since been lifted. Experian and TransUnion have similar services.  The downside to credit monitoring, in my opinion, is that it reports an incident after-the-fact. Granted, the more robust services offer near-immediate alerts, but it is still after-the-fact notification.  It is also not inexpensive to have all three bureaus monitored on a daily basis.  Your financial institution may offer such a service on a discounted basis. It is worth checking with your bank.

4) Utilize a spending planner / monitor that provides alerts.

Downloading into Quicken or Mint.com and reviewing transactions frequently can also help you detect anomalies in existing accounts.  For those who are using the spending module of the D. Scott Neal, Inc. website, alerts can be set to monitor large expenditures. The amount that constitutes “large” is user defined.

Like credit and ID monitoring, these are also after-the-fact and require considerable attention and fast action when something shows up.

Even if this breach of Equifax never results in your data being used fraudulently, it is a wake up call for all of us to be on alert. Cybersecurity should become a very high priority for all of us. I will publish more about how to hack-proof your life in future editions of the blog. Meanwhile, scroll down and leave a comment or question.

September 11, 2017

Thinking about the stock market

Time does matter

How’s your algebra?  You know . . .  x + y = z.  If you know one factor, you know a bit but cannot solve the equation.  If you know two, you can probably figure out everything about it. Apparently, the news media and many investors believe that this is all there is to figuring out the stock or bond market. Pundits are prone to reduce their explanation of the markets in just such simple terms.  I probably should just let it go, but I continue to be confounded by the way, at the end of the day, the media explains how that day’s events have shaped the market. I understand that we human beings have a strong and undeniable desire to establish a cause-and-effect relationship between two things especially when we perceive that one affects our life. For example, we truly want to believe that what goes on in Washington or somewhere else around the world will help make sense of the daily gyrations of the financial markets. True news flash: the markets are much more random than that. The truth is that in the short-term, certainly in a period of less than a year, political, fundamental, and even economic data have very little to say about what goes on in the market from one day to the next.  There are exceptions, but they are rare.

Part of this conundrum is grounded in our perception of time, or perhaps the lack of a clear perception of market time. Dr. Alexander Elder cautions that the we need to first become aware that market time is much slower than our own.  When they hear the daily news, I fear that few people stop to consider that the market moves in multiple time-frames.  It moves simultaneously over years, months, weeks, days, and even hours and minutes–often in contradictory directions from one time frame to another.  The trend of the market may be up on a monthly and weekly basis, but down today. Or vice-versa.

What the news commentators miss is the context of the daily moves as they play out in longer time frames.  I believe that one should start with a longer view to gain strategic perspective, and then analyze a shorter time frame to figure out what you are going to do within it.

Many advisors will coach their clients toward becoming a long term investor–with a view toward years. One has to ask what “long term” really means.  Usually to the advisor it is an admonition to be patient with what can become severe drawdowns. The chief advantage of the long term view is that it eliminates the need to pay attention to the daily news. Because the markets have a bias to increase over long time periods, you could see rather large gains over long periods of time–but not always.

At the other end of the time spectrum is the day-trader.  Actually the title is a misnomer because a true day-trader has an expected duration of holding an investment measured in minutes or hours, not even an entire day.  Most day-traders end the trading day in cash. The folks who do this see many opportunities, because the market can move up and down very quickly. However, trading costs can mount up and eat away at return. It also requires a vigilance and dedication to investing that few people can maintain.

A middle ground is what the investing industry calls swing-trading.  The expected duration of a holding using this time perspective is usually days or weeks.  There are lots of opportunities offered to the swing trader, and he or she can match the opportunities with reasonable risk controls. The downside to this type of trading is that you can easily miss big trends by getting in too late and / or out too soon. It is possible to produce outstanding returns using a trading strategy, but that depends on the quality of  your trading system.

One step in goal-setting is to have a proper time dimension for each of your goals. Consider the goals of your investing and match the time-frame of your investing with the goal. For most people, this will mean tuning out the daily market report. But if you do listen to it, be sure to stop and place it in the proper context. It is also vitally important to consider the time-frame when you look at quarterly reports or monthly statements from the custodian of your funds.  Too many investors tend to make knee-jerk reactions based on a time-frame that is totally disconnected from their true investing goals.

Leave me a comment or question. I would love to know your thoughts on this.