Be A Proactive Investor

During volatile times in the market, like what we have been experiencing since May, it’s difficult to see through the disparaging news headlines (Oil is Collapsing! Bear Market in Stocks! US Is In A Recession!) and not to lose sight of the forest for the trees. Investing is a long-term game with seemingly unlimited number of opportunities and it’s imperative as an investor to not get caught up in the day to day swings (and explanations) of the stock market. It’s times like this where a word like “casino” gets tossed around as a synonym for the stock market. And you know what, in the short run the market is a lot like a casino. One day the market is up, the next day the market is down. Don’t believe me since it feels like the market has been down a whole lot more than its been up lately? Well, would you be surprised to know that over the past 200-days developed world equities have been up 47% of the days and down 53% of the days. Pretty close to a 50-50 coin flip, right?

Percentage Of Positive Performance Days For Stocks

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But long-term investors know that the stock market isn’t really like a casino at all. The “payoff odds” in the stock market are not static like they are in a casino. Hitting the right number in roulette will always pay 35:1 but investing in the right stock could return 10% or it could return 10,000%. Therefore, it’s key to think of investing in terms of probabilities instead of binary outcomes. Investing is not about calling the top or bottom in the market exactly right. It’s about understanding if there are more positive investment opportunities in the market than they are negative opportunities (or vice versa). Put another way, its about properly identifying where the market currently falls on the risk/reward spectrum. This way you as an investor can be proactive rather reactive to changes in the market.

We have known for quite sometime that this is the longest running cyclical bull market in a secular bear market so a selloff like the one we are in now was bound to happen sometime. And in the long-term that is actually great news for investors because future returns have undoubtedly improved thanks to the opportunity to buy stocks on “sale”. But this is where investor psychology really comes into play. If your risk antennae was not tuned up to the fact that the probability of a selloff had increased (i.e. the opportunity set had shifted from more buying opportunities to more selling opportunities), than it’s really difficult to realize after a 15-20% decline that the opportunity set is ALREADY shifting again back into your favor. You are reacting to the declining market and when you are reacting it’s hard to make the correct rational decision. To sell stocks into a declining market is always hard because in the back of your mind you know you missed out on the optimal time to get out and it’s so easy to tell yourself “I’ll sell out of stock XYZ just as soon as it rises 5-10%”. Of course, in a slide like we are in now its very rare for the market to ever give you that 5-10% gain and so you sit on the underperforming stock far longer than you would have liked. However, if an investor is proactive in identifying where we currently sit on the risk/reward spectrum, there is a very good chance that that investor had begun to shift his or her portfolio into more defensive sectors and perhaps into cash as well .While they would have been undoubtedly early and missed out on some of the gain back in May, they are already mentally prepared to began to take advantage of some of the positive opportunities that are presenting themselves in this correction. This is why at Gavekal Capital we focus so much on risk management. Yes, risk management is about protecting the downside. But more so, it’s about being proactive in your investment process so that when the risk/reward spectrum flips in your favor you are ready to take advantage of it and capture the gains in your portfolio.

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